The funding bubble

Funders, mainly Venture Capitalists, exert the most dynamic influence on the startup ecosystem. Without external funding, many startups won’t scale and without rapid growth, startups get left behind due to stiff competition and advances in technology. The role funders play in stewarding the growth of startups is crucial, but the way funding is currently structured is such that founders are programmed to seek exits at IPOs and acquisitions more than to build legacies (which is why I prefer to bootstrap).

The problem this immediately poses is that founders build functional debt-ridden entities that are more desirable to investors and M&A firms than they are to customers and employees. This means that debt and liabilities can be overlooked as long as founders can develop their functional entities into purchasable brands.

This begs the question, are funders not wary of the risks associated with investing in startups?

Simple answer, they are. The technical answer is the greater fool theory. The greater fool theory is a trading strategy in which investors make risky investments by betting on a “greater fool” to buy their stake in an investment at a higher valuation than they got it. The engine of this strategy is speculation based on irrational exuberance.

There certainly is no shortage of “greater fools” as more inexperienced investors (formerly founders) continue to invest in startups that lack fundamentals—paying little to no attention to due diligence—as a way of giving back, while inadvertently thinning the bubble.

History has shown us that the bigger and more exciting a bubble is, the more devastating the effects of a burst will be. It’s an interesting conundrum if you ask me.