Exponential Growth

Question : Why do startups, (especially software companies) raise money?

Answer : They are unable to cover their expenses with revenues generated (in the early days). In order to stay alive, they need to raise a chunk of capital. This gives them a runway (amount of months you can continue to pay your bills/ employees), which allows them to build, scale, hit revenue goals, and ideally, raise another round.

This is also why you hear about startups raising multiple rounds of funding:

(Pre) Seed -> Series A, B, C, D, E, etc.

They were at the end of their runway (or didn’t have one to begin with) and needed to raise capital to cover expenses and continue to grow.

I recently took a job at an early stage software startup. Now, a lot of people have asked/thought, why would you take a chance at a startup? There is so much uncertainty, you're going to have to move across the country, change your life, and what are you doing to do if it fails!?

There isn't just one answer to this question, there are many. I like building stuff, so being in at the ground level of any company is appetizing. Writing the playbook for bringing something that didn't exist, (or was almost dead) back to life, is arguably the hardest (and most exciting) thing you can do professionally.

But the primary reason is the potential for exponential growth.

Exponential growth is the reason that Amazon, Google, and Microsoft are the biggest companies in the world. It is the reason that funding is available for startups in the first place, and why Venture Capital firms not only exist, but employ some of the smartest, most successful and well connected people in the world. 

Exponential growth is the reason companies (especially software companies) are able to raise $9M at a $200M valuation with <$1M in revenue.

Here is a visual representation of what exponential growth looks like:

Red = Linear

Blue  = Cubic

Green = Exponential

In the above graph, think of large corporations or established businesses as the red line. They are looking to grow +/- 10% YoY, and have been doing that for the past 20+ years. Which is great!

But at a startup, you have the ability to be the Green Line. The hockey stick.

Now, granted, it takes longer, and is definitely riskier, but you have the ability (if successful) to not grow 10% YoY, but 1200%. That is the power of exponential growth. More on this phenomenon by Paul Graham in his piece, Startup = Growth.

Let's break out the numbers in the above chart and pretend that the X axis is months to help wrap your head around actual numbers:

Red = Linear

2 months = 50x2 = 100

8 months = 50x8 = 400

15 months = 50x15 = 750

Blue = Cubic

2 months = 2^3 = 8

8 months = 8^3 = 512

15 months = 15^3 = 3375

Green = Exponential

2 months = 2^2 = 4

8 months = 2^8 = 256

15 months = 2^15 = 32768

Look at how silly the things start to get when exponential growth is applied for a period of time. 32,000 vs 750. It's a 42x difference.

So you can't apply the fundamentals of established, blue chip companies to the startup world. You can't run the traditional Wall Street financial models and expect to get a perfect valuation at a PE ratio that makes sense.

Companies that realize the exponential growth rate are extremely rare, and absolutely do not play by the rules.

It's exciting to have the opportunity to try and build one 🙂.

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