Finding the right way to fund student startups
Is enabling students to do something better than having them do nothing?
Learning To Fly Ventures (UChicago's student-run venture fund) continues to have an internal dialogue regarding the correct way to allocate our funds. This dialogue doesn't necessarily revolve around answering, "How big is this market opportunity?" and “Is this going to return our fund?” That's because, even as a "venture capital" fund, our primary objective is not to generate returns for our LPs. This non-objective is evidenced in the fact that a) we distribute an alumni donation, and b) we don't take equity. Hence the quotes around "venture capital" above; we're essentially operating a philanthropy.
That being said, the questions we ask ourselves are more in line with philanthropy: there is some change we want to see in the world -- what allocations are a means of achieving that change? The change LTF wants to see is increased entrepreneurial activity at UChicago. In the same way many organizations in the world aim to solve climate change, many students at UChicago are flirting and engaging with entrepreneurship. However, this is where the difficulty and vagueness in our decision process emerges: what kind of entrepreneurial activity should we promote?
My use of "kind" here refers less to the sector or type of product (software versus CPG) and more to quality. That is, there are many ways that one could build a business. Some of those ways, which I understand through mentors and literature, are better than others. An example might be lean spending — more runway gives you more time to iterate and find product market fit. Thus, founders should try to reduce their burn. However, this cause / effect relationship one might use to analyze a particular practice's efficiency isn't always so clear. My personal experience working at Techstars Chicago under Neal Sales-Griffin highlights this point. To put it briefly, although there's undoubtedly more nuance, the Chicago approach to startups emphasizes traditional business fundamentals (understand the problem before you build, have hard metrics, and spend frugally) compared to the moonshot vision that Silicon Valley backs (launch quickly so you can iterate, have a big vision, subsidize customer acquisition). I hope people don't get too caught up in these examples — they're meant to illustrate that different people emphasize different practices.
Returning to our mission, we encounter some practices of student founders that we have difficulty determining whether or not they are worth supporting. Some examples include no code versus hiring code versus in-house code, the scalability / market of a business, project versus real startup, and GTM strategy. Some people might have harsh stances on some of these issues. For example, some might believe that a startup without in-house development that outsources all of its code should never be funded — they don't have the ability to iterate quickly and cheaply on customer feedback. Another example might be (and we get this one a lot) Paul Graham's comparison of a project versus a real startup: "Class projects will inevitably solve fake problems." It's the gig-economy app for college campuses — the pains exist theoretically and maybe even literally. Still, even if a solution is presented, the pains are not big enough that people will change their behavior. In this case, one might think that the startup shouldn't be funded because the problem is not painful enough (or even real).
The rationale behind not backing startups with these bad practices appears very straightforward and validated by practicing venture capitalists everywhere. Their ability to contribute to, and thus be compensated from, the market aren't worth taking bets on. However, as outlined before, LTF isn't concerned with making returns. We're concerned with promoting entrepreneurship. Thus, even if we decide that a specific behavior is undesirable and would not be backed by real venture capitalists, we ask ourselves: is doing something better than nothing?
What I mean by this question is this — building a startup requires you to do many things. So, even if the pain isn't that big or you have to outsource your code because you're non-technical, can you learn from everything else you must do? We're trying to understand if the cost of enabling bad habits is worth promoting good ones. That might be subsidizing a GTM strategy so the student can learn what that process is like, even though the pain they're solving isn't real (or is minimal). It might also subsidize efforts to outsource code so that students can practice building products and features based on user feedback they've collected. These examples can go on and on, combining the subsidy of some bad habit (outlined above) so that students can experience one aspect of what it's like to build a startup. These experiences are valuable: cofounder dynamics, working with developers, time management, product building, customer interviews… But, are we harming the founders by enabling this bad behavior that’s one part of a good learning experience? Are we positively reinforcing them for a behavior they're unaware of, thus causing them to associate that reward with a behavior we don't want to reward?
I don't think that the answer is zero-sum: they have to have everything right for us to fund them. That seems unrealistic, not only for college startups but for startups everywhere. A common saying is, "Experience is how you learn." And that learning is certainly what we're trying to enable: the experience of building a startup.
I think scrutinizing this saying is where we might find some answer. The experience itself isn't where you learn but rather when you reflect on an experience — looking at what inputs lead to what outputs; a postmortem (or post-parade!). So, that's one way to approach it: after the funding has run out, or while it is running out, sit down with the founder and figure out what went wrong. But that reaction is too delayed and sounds like another harmful practice we could be promoting — founders in the real world don't have that luxury. Analysis has to be done while it's happening: decreasing burn, cutting people, pivoting. We'd essentially allow a team to run out of money, which is not a good practice for either party. So let's not do that.
The answer then seems to be taking a more active approach to managing these startups. That means we are prepared to help teams make adjustments of their bad practices to get them closer to good ones, recognizing that not everything will be perfect at the beginning. If the team can't code, let's find that team someone who can code. If the pain isn't strong, let's conduct user interviews with them in a similar space to find a real pain. If the GTM is weak, let's develop a better one. Quite honestly, making these adjustments doesn't require us to fund them — so maybe before we make any funding decision, we ensure that the practices that LTF would enable these founders to practice through funding are ones that we're comfortable with.
While this time commitment to potential investments (and bad port-cos) may be unreasonable for real venture capitalists who would face a tradeoff with investing resources in their better port-cos, the commitment is not unreasonable for us — our goal is not to generate returns. The tradeoff we might have to make is working with teams that have different levels of commitment and less practices to correct. So, those two items should be considered in our investment decisions: How dedicated is this team? and How many bad practices do we have to correct? By looking at the commitment of working with this startup in relation to our existing obligations, we can decide what teams would benefit most from our support. I use “benefit” here to describe that a team will use, not could use, our help. In other words, we help teams go from okay practices (the problem they’re solving, GTM, market, product development) to good ones, not terrible practices to bad ones. Better teams would be more open to support and change that leads to growth; bad ones would want the latter without the former. Furthermore, this belief in choosing of teams and not ideas is already largely practiced by venture capitalists, which makes me more confident in this conclusion. At least at the early stage, betting on the founders and not the idea is the common practice. Thus, even though the objectives of LTF and real VC are different, the means through which we maximize the potential of success are similar, if not the same. Plus, by focusing on how to support founders, and not just choosing what to invest in, LTF learns how to meaningfully contribute to startups — which is what the ideal primary function of VCs.
In hindsight, this active portfolio support based on team dedication and existing practices seems like the obvious answer because it's what most venture capitalists do. Many of them, like Thrive Capital, emphasize that they do this more than others and are good at this portfolio support. But, in full transparency, it took me thinking about this problem before and during writing all of this to figure it out. But now, I finally have some resolution, and more so, a resolution that I can share with my LTF colleges and UChicago startups.