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What's Wrong With Seed Funding

The model isn't working, says one founder. Investors aren't doing enough to encourage "ignorance" and "dumb ideas." Here's why he's right.

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One of the most fascinating and frustrating aspects of entrepreneurship (and of covering start-ups, by the way) is that some of the most popular, successful tech companies seem to achieve greatness almost completely by accident. They are, in a sense, almost completely unpredictable. 

Take, for instance, Google, whose founders started their business as a research project and remained so unconvinced of its potential that they tried to sell the company for $1 million in 1999. Or consider the story of Instagram's Kevin Systrom and Mike Krieger, who were so taken off guard by their app's initial traction that their servers crashed the day they launched. (For every success, of course, the list of massive failures is much, much longer.)  

To cope with this unpredictability, investors, for their part, have adopted a wide variety of strategies to try to spot winners, from moneyball-like funds to the spray-and-pray accelerator approach. But on aggregate, investors haven't been seeing such great returns lately

Part of the problem, some argue, is that seed-stage investors are approaching start-ups and founders fundamentally incorrectly. Josh Miller, a founder of Branch--a topic-based social network backed by Obvious Corp.--articulates this problem particularly well. As he writes on Medium:

At the core of the problem is the way investors evaluate early-stage startups. Provided you have a talented team, your ability to raise a seed round (and the terms) largely depends on two things: your product and "vision."

...

Furthermore, even when the game-changing idea is discovered, the founders and early employees tend to underestimate its magnitude and potential. They'll tell you that they knew the product was special but did not realize how special it was or what it would lead to next.

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Despite these patterns, investors require conviction and grandiosity from budding entrepreneurs. As a result, most "dumb" and "small" ideas never make it to pitch meetings or even prototyping, and instead die in the heads of talented builders... Which is a shame, given that Facebook, Twitter, Airbnb, Dropbox and the like were all initially "dumb" and "small."

In a world that praises the "big idea," Miller's point is counterintuitive. But I think he's fundamentally right, and I'd also add this: A universe-shattering idea is a noble goal--but you're a lot better off tinkering with the problem right in front of you, even if it doesn't seem significant. 

That also means our notion of who makes a successful founder needs to change. On one end of the spectrum, you have talented product and engineering people eager to make something--anything--out of nothing. (You'll tend to find a lot of these engineers hanging around hackathons and the like.) On the other end, you have more traditional entrepreneurs--founders with business plans and a clear idea of what they're creating, who they're creating it for, how it will work, how much it costs, etc. But there is also a range of potential entrepreneurs, from a variety of professional backgrounds, that have an itch to make a certain aspect of their industries or lives better. 

The ideal entrepreneur--if there is such a thing--is probably somewhere in between. Miller describes them like so: "Entrepreneurs who are thesis-driven and implementation-agnostic." To me, that means they are founders who believe something about the way we do things is fundamentally broken--or at the very least could be improved. In other words, start with a firm belief in the problem--not the mechanics of any one particular solution.

"If the startup ecosystem wants to increase the rate at which world-changing companies are created it needs an early-stage funding model that encourages ignorance and experimentation," Miller writes.

A model that encourages "ignorance" may sound extreme--and a bit reckless, especially if you're dealing with a VC's money--but it makes sense. Founders need the flexibility and freedom to run with an idea, even if that idea seems small in the short term.

IMAGE: Getty
Last updated: Jul 17, 2013




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