Why following fluffy VC advice is actually a bad strategy

For 20 years Silicon Valley VCs have been preaching a toxic startup gospel.

In this newsletter edition, I’m going to break down a core pillar of that gospel and why you should ignore it and pursue a different set of business principles.

First, let’s go over their incentive structure and why you should suspect their motives, then we will go over what VCs are teaching poorly and how Indie Hackers and solopreneurs - or anyone who doesn’t plan to raise venture funds - should be thinking differently.

What VCs want you to build

Even though VCs have become the arbiters of what makes a great startup, they are not incentivized to help us build great companies.

In some sense, that depends on how you define a “great” company. But for most VCs profit is not something that would be heavily weighted in their analysis of what makes a company great. And if the goal of a company is not turning a profit, it’s as much a Ponzi scheme as a company.

That’s why the startup community has been so vulnerable to people like SBF, Elizabeth Holmes, Adam Neumann, and Billy McFarland, along with the hundreds of web3 rug pulls and no-name entrepreneurs who had just as shitty ideas but never made big enough news to be mentioned.

VCs don’t make money when a company makes a profit. All their money comes from valuation and liquidation events.

Their term sheets with their limited partners are usually something like 2/20. This means they take 2% fees on what’s under management annually, and 20% of the profits made via their investments.

In this situation, they make the most money by increasing the on-paper market value of the business. Very different attitudes than Warren Buffett and Charlie Munger, who insist on investing based on a company’s intrinsic economic value.

In a second we will get into how the VC incentive structure has infected the minds of entrepreneurs, but first, are VCs wrong?

Well if there is an intellectual debate between Berkshire Hathaway and Andreeson Horowitz on what makes a business great, you’d be silly to side with anyone other than Warren and Charlie.

Warren and Charlie built one of the top 10 largest companies in the world by market cap from Omaha Nebraska.

They did this with less than 15 people at their headquarters. And at the end of the day, you’d think that the largest shareholders in a company like Apple would be VCs.

But no. At the height of Apple’s dominion, Berkshire is the biggest shareholder, not a VC even though all they had to do to keep the title was hold.

So if you are trying to build a company for yourself, and you are not going the VC route, you should stop reading Paul Graham, Andreeson, Naval, Reed Hoffman, and Peter Thiel.

Instead, you need to accept the gospel of Warren Buffett and Charlie Munger.

So what is the common advice given by VCs that you should avoid?

Don’t Worry About Profit.

There is a fundamental attitude among silicon valley startups to save profit for last. They claim to have a good reason for this.

VCs don’t like profitable companies because then accountants will set the value of the business.

Instead, they want sales and marketing people (fundraisers) to set the value of the business. This way they can claim the business’s potential as the business’s value. The net result is delusion. The business is valued based on intangibles because the tangibles are lackluster and not very compelling.

They also don’t want you to make a profit because that might deter you from fundraising. Every seed investor’s goal is to get you to your series A. Your series A investor wants you to get to your series B, and so on it goes.

A good example is Facebook. Zuckerberg was raised by VCs. You can see it in his decision to spend $250B on a metaverse that never took off and he ultimately abandoned. He thought we was still playing in a delusional land.

But with rising interest rates the veil of delusion dropped and investors could finally see again that profits are what really matter.

Facebook, a company perfectly capable of turning out incredible dividends to its investors, lost 60% of its value in a matter of months.

Though, after Zuck begged and promised that he would focus on prioritizing the shareholders with buybacks and spending cuts, the stock went up 98% in an equally incredible amount of time.

If you want to build a product for short-term investors to make money off of, don’t worry about profits. If you want to build a company, on the other hand, profit is exactly the metric to focus on.

Conclusion

One of the hallmarks of a good strategist is understanding what rules, practices, customs, principles, and laws apply to you and which ones don’t - we will call those things ‘gibberish’.

If you are mindlessly taking in the gibberish of the day, thinking they apply to you as well, you’ll never get where you want to go.

The key is zooming out so you can see the entire chessboard. To a VC, a startup is a pawn. Sometimes one of those pawns makes it to the back of the board and becomes a queen, but the game is not played in the best interest of the pawns.