Any new venture is risky. Unfortunately, we have created a set of norms around starting a company that mean it is common for founders not to have skin in the game. By raising VC capital, founders trade their skin in the game for runway. This makes it more difficult to make good decisions, leading companies to fail (often slowly). I’m not suggesting that there are never reasons to take outside investment. Obviously there are. But, we should recognise that doing so comes with significant trade-offs and difficulties that mean it shouldn’t necessarily be the default.
New ventures are (by virtue of being new) based on a set of untested assumptions that make them fragile. When starting something, your highest priotity should be to either remove this fragility (by removing risks), or to fail fast1. The most effective way to do this is by having skin in the game (i.e. to have measurable risk when making a major decision).
The knowledge we get by tinkering, via trial and error, experience, and the workings of time, in other words, contact with the earth, is vastly superior to that obtained through reasoning… 2
By raising money, it can feel as though you’re making your company less fragile. You can now pay your employees a salary and afford to pay the rent on a nice office. However, what you actually have is the luxury (and responsibility) of having a company before you’ve actually built it. This makes it more difficult to make decisions because you and your team are no longer in “contact with the earth”. You’ve loosened the grip of a particularly important constraint: time. Time acts as a forcing function for us to make better decisions and more practical trade offs. Now that you have time, it can be harder to prioritise as ruthlessly as it otherwise could have been. Ultimately, it’s easier to lose focus because you’ve created distance between yourself and the reality that you don’t (yet) have a sustainable business model.
Things designed by people without skin in the game tend to grow in complication (before their final collapse) 3
The alternative is to forgo raising money and creating a sustainable business from the beginning, growing linearly with the number of people that give you money for your product. This ensures that the only way for you to grow is by solving customer problems that they will give you money to solve. It means that your incentives are squarely aligned with that of your customers4. Not only that, but because you don’t have the safety net of a pool of money, you are forced to find the fastest path to sustainable growth. You now have no choice but to be ruthlessly focused on the things that impact your bottom line (i.e. pay the bills). It can often feel like you’re making progress de-risking something when you’re actually just treading water5. Having skin in the game makes it abundantly clear when this is the case because you can no longer pay the bills.
This model more clearly reflects reality. The truth is, you only ever have a business that is as good as the number of customers willing to pay you. Why not make this the foundation of your decision making?
In general, humans will try to avoid failure at all costs.↩
If your incentives are aligned with your customer it helps to ensure that whatever you create remains fair to your customers as you grow.↩