VC-backed startups prioritise growth over quality. Corporate venturing can fix that

In a past life, at the height of the dot-com era, I ran a venture fund. We had $200m in capital, made 27 investments, and, despite our inexperience, achieved five exits.

I therefore know first-hand the unintentional damage that VCs can do to their portfolio companies. This manifests by pushing relentlessly for maximum growth with the promise of huge capital raises at dazzling valuations in future rounds. All the while oversimplifying – or simply overlooking – the many real life operational, organisational, and customer service challenges that early-stage companies face.

By pushing for hyper growth and stipulating that 100% growth a year is a baseline, VCs turned the startup growth equation into something of a crack cocaine cycle. This blitzscaling concept pioneered by Reid Hoffman made perfect sense for a tiny number of companies in very specific circumstances, but not for most startups. It should have been the exception rather than the rule.

But in reality, this blitzscaling strategy, along with the dizzying growth in valuations and check sizes we saw during the zero-interest rate period, increasingly became the norm through the low-interest rate period. As a result, it now takes real strength of character for any VC-backed founder to say to their investors: “We can’t – and shouldn’t – grow as fast as you want us to. We need to balance growth with quality, operational stability, organisational maturity, and customer satisfaction.”

In short, for VC-backed entrepreneurs, it’s harder than ever to resist the new mantra of “get big, then get great” — even though luminaries like Steve Jobs clearly believed the opposite. However, this very phenomenon presents corporate ventures and their sponsors with a fantastic opportunity. And it stems from their very different incentives.

The sad reality is that many VCs – particularly the newer firms – haven’t actually been in the business of maximising distributable profits for their investors. Instead, they’ve been in the business of maximising ‘marks to market’ on their existing portfolio; to demonstrate that the companies they’ve invested in have risen in value. They then use these ‘marks’ to demonstrate to LPs that they are successful investors and persuade them to invest more money in their next fund.

As unfortunate as this tendency is, it makes sense for VCs who are sub-scale. With a fund of $100m or less, the management fee isn’t enough to cover even their fixed costs, so growing assets under management as quickly as possible is a sound strategy for them — just not one that is necessarily in the best interests of their portfolio companies.

But compare this to corporate venture investors – their underlying motivations are very different.

First and foremost, corporate venturing arms are more risk averse. They care deeply about the quality of the products and services their ventures offer, as well as the experience of their customers. Especially given all these elements are likely to reflect back on the parent company.

Second, their core objectives are often to generate insights into new markets, demonstrate the potential of new business models, and forge beachheads that may have long-term strategic value to the parent. None of these goals depend on hypergrowth.

Then comes funding. While most corporate venture investors also want to attract third party capital in the longer term, they are much less dependent on this. They are much less likely to face the existential threat of insolvency (in the short term). Their salaries are generally not dependent on the amount of capital they manage, so they don’t have a strong incentive to grow AUM as quickly as possible, as VCs do. Their ability to access additional capital down the road — whether for new investments or for follow-on investments in existing ventures — is much more closely tied to the actual progress of those ventures, measured on a balanced set of criteria, than it is to any one vanity metric, such as year-on-year growth.

Finally, there is a big difference in mentality. Corporates understand that building a business takes time. They understand that refining processes, building infrastructure, stabilising operations, and maturing the organisation take time. They know all too well that the quality of these things matters as much (if not more) as the rate of growth, as they are what truly drive customer satisfaction, margin, sustainability etc.

While in the short term businesses backed by corporates may seemingly lag behind some of their “go faster” VC-backed competitors, this patient approach, focused on product and operational excellence, and customer satisfaction, is very often a path to long-term success. This is in keeping with the fact that the long-term strategic benefits typically outweigh short-term financial milestones as the key determinant of success.

The hidden advantage — organisational effectiveness

The biggest unintended side effect of blitzscaling — and the one that has been least appreciated by both VCs and founders alike — is its impact on organisational effectiveness. When organisations grow too quickly, they nearly always become mired in dysfunction and inefficiency. Why? Because the complexity of an organisation grows exponentially, even as its headcount grows linearly. The result is that the highly aligned, smooth running organisation you had when you were 50 people is starting to show signs of strain at 100, and by 150, is very likely to be exhibiting what I call the 3 Bs of organisational dysfunction — Bottlenecks, Bureaucracy, and Bickering.

If there’s one thing I’ve learned from advising the CEOs of more than 50 startups and scaleups, it’s that too many have confused two terms: scaling, and growing. The meaning of growing is clear enough. But scaling means something different. It means “enlarging something while preserving or enhancing its essential properties.” A truly scalable organisation is one that is as efficient, aligned, apolitical, and smooth running at 200 people as it was when it was with 20 people.

This is not easy. And, as we’ve seen, it doesn’t happen naturally. It requires a lot of effort and care. Frankly, it calls for much more sophisticated and mature leaders, and more experienced managers, than many of the young, brash VC-backed companies have. Corporate parents and partners are the natural recruiting ground for these kinds of leaders.

Since the market downturn, we’ve witnessed many rounds of layoffs in tech — proving that Warren Buffet was right when he said “only when the tide goes out do you discover who’s been swimming naked.” Too many VC-backed entrepreneurs have been caught swimming naked, with bloated, dysfunctional organisations.

Corporates can – and should – focus on producing companies that get ‘great’ first, and big second. The ”move fast and break things” mentality made famous by Facebook is hardly the only route to success. By adopting a smooth scaling approach, corporates can produce better, more cost effective, and more competitive companies with a long-term outlook. Corporate venturing arms are perfectly placed to take on this mantle.

Rob Bier is the author of Smooth Scaling: 20 Rituals to Build a Friction-Free Organization.