The Crowded Restaurant Theory and Why VCs Get It Wrong
The metrics through which venture capital views internet based startups are all mashed up to their own detriment.
In 1999, when I was a sophomore in university I visited a ‘dot.com’ era startup as part of a school project. That was when the whole culture of ‘it’s hip to be in a startup and go to work in t-shirts and sandals’ started.
And that was exactly how the founder of that startup was dressed. He sauntered in 20 minutes late and then proceeded to brief us on what his company did and how it was all about the number of eyeballs they got on their website. Revenue didn’t matter. In fact, they were simply creating it to ‘hoodwink’ investors by exchanging advertisement banners with other dot.com startups.
That era was the first time in human history that traditional business metrics (i.e. revenue and profitability) got thrown out the window. The idea that one could, and indeed should, invest in businesses that not only didn’t make money, but would not make money for a long time to come — was actually good, and should be encouraged.
It wasn’t that that theory was actually wrong. In fact, through two decades of different internet-based startup themes (portals, social media, e-commerce, cloud, marketplaces, sharing economy, crypto, SaaS etc.), many unicorns had been created on that very basis in their initial years of operation, changed hands for billions before even making a cent, and eventually came out on top to become internet legends.
Think Google, YouTube, WhatsApp, Instagram, Facebook etc. etc.
So what went wrong? Why are VCs today so afraid to invest in anything that doesn’t make money from day one?
I call it the ‘Crowded Restaurant Theory’.
If there’s a queue it must be good
The problem with opening a new restaurant is this. Nobody wants to be the first sucker to go in and try something that tastes awful.
But once a queue starts to form, curiosity gets the better of people and more people actually join the queue just to try.