The Founder’s Paradox - where startups go to die.

Los Alamos c.1950 Italian-American physicist Enrico Fermi sat down to lunch with his colleagues at the National Laboratory - he was working on the nuclear bomb as part of the Manhattan Project.

As legend has it, the conversation turned to life beyond our Earth. Into this, Fermi issued a statement that would go down in the annals of history: “Where is everybody?“.

Soon after came the concept of a "Great Filter". Why are there no extraterrestrial civilizations in the observable universe that we know of? Maybe life has evolved many times on distant planets in our galaxy but each time it reaches a certain point of development, life evolves to a stage where it can go no further. Maybe because of some event that wipes it out: asteroids; gamma-ray bursts. Or maybe some invention: nuclear weapons; biological weapons; climate degradation. Somewhere in our future, a Great Filter event that life itself cannot pass through.

This concept can be applied to startups at each phase of their development. There is a dominant common reason for failure at each stage for startups:

At the seed investment stage a failed startup is one that has not achieved labour productivity. This is just a polite way of saying the team does not come together in a meaningful way. There is no gelling of efforts to produce even a single good output. Usually, a team that does gel, that does produce good work, will generate enough kinetic energy of sorts to get continued funding.

Post initial funding but before the series A round there is another single cause of failure: the inability to get product-market fit. These are businesses in search of a demand curve. They either find one, or they don't.

This is where the highest element of pure chance exists in a startup.

It is like the prospecting days of the Australian gold rush. You can be a great operator or a decidedly average one. You can do the right thing. You can do the wrong thing. But nonetheless, there exists some irreducible amount of pure chance. The wisest prospector with the best tools, best knowledge, the most intelligent strategy, sometimes just won't find gold. Someone else will trip over a rock, bump their head on a gold nugget, or put the pan in a stream and gold will just come out.

There is an intractable nexus of serendipity at this stage.

At series A it becomes about labour productivity - again - but now it becomes a question of management being able to scale. People's careers in general, the early stages, and the personalities that go into them, often have a negative correlation with the later stages. For a successful McKinsey or Goldman Sachs analyst they need attention to detail, strong work ethic, high diligence, high conscientiousness. In middle management at those companies, they need good project management, good ability to abstract and structure problems, good ability to pull a team together and create team moral. The complete attention to the detail and technical knowledge matter less. And then if you look at the partner level in those firms, often what matters is relationship building, salesmanship and charm; the ability to empathize with the client and connect with them. It is hard to find people that star in all three parts of those careers.

It is the same with entrepreneurship. The street smart entrepreneur who can raise money with a good narrative, good energy, and can recruit people to create a sense of momentum and esprit de corps, is often very negatively correlated with a sort of personality that wants to put in quarterly HR reviews and QBR reporting. Conversely, the entrepreneurs that do very well later find the early-stage capital raising hell on earth. It can be because in some ways they are more tightly gripped to reality, slightly pessimistic, and fairly good at avoiding chaos. This can often make them very bad at pitching their startups.

For series A companies at ten people or less who are spending time with each other every day: everyone influences everyone else. Because of the strength of personal relationships, as long as a founder is articulate, energetic, and engaged, they generally do not have to manage. The team manages the founder up. But beyond series A, when a business scales from 30 people, to 90 people, to beyond, and the founders no longer have the personal connections of earlier stages, managers have to move to formal techniques. Like the Fermi Paradox Great Filter, this wipes out an amazing number of startups.

The way it happens is through the collapse in labour productivity per person: in microeconomics, this is called managerial dis-economies of scale - the angle of the decline of productivity per person is the difference between the great startups: AirBnB, Stripe, Twitter; and the failures.

For a great startup, as you go from ten people to 100, output per person may drop 15%. For a bad startup, it drops over 90% with the result often that a 100-person startup can produce less than they did when they had 10 people. The managerial collapse can be extreme. A great company is one where executives spend only 25% of the time playing politics; a bad one is where they spend 50%. That delta is the entire Gaussian bell-curve from the best Fortune 500 company to the worst.

People that become entrepreneurs are often full of energy and flexibility – a combination of streets smart and book smart. Now that they have hit product-market fit, what they are doing is repeating a process at scale. To repeat a process at scale, leaders need to build institutions. Often that is an anathema to their entrepreneurial personality.

To take revenue from 35 countries, you need a well-developed finance department. Once you get to a certain size, you will always be in court cases: being sued by ex-employees, patent infringement, debt collecting customers that didn't pay, etc. The shift is to build an institution with institutional norms, and institutional boundaries, and institutional culture; all the boring stuff of building. From finance departments to legal departments, to HR departments. That again is a big filter.

So for the humble early-stage investor: one interesting process is to try to imagine the person you are backing for a startup today, on a public company conference call in the future. Can you imagine them sitting as a CEO, next to their CFO, talking with wall street equity analysts and the buy-side on the phone and being credible enough, deep enough, and mature enough to pull that call off?

Companies can grow faster than their leaders can gain leadership experience; a final Great Filter.