[Henry] Mosley decided to let the meeting run its natural course before bringing up his concerns. Theranos had just closed its third round of funding. By any measure, it was a resounding success: the company had raised another $32 million from investors, on top of the $15 million raised in its first two funding rounds. The most impressive number was its new valuation: one hundred and sixty-five million dollars. There weren’t many three-year-old startups that could say there were worth that much.
One big reason for the rich valuation was the agreements Theranos told investors it had reached with pharmaceutical partners. A slide deck listed six deals with five companies that would generate revenues of $120 million to $300 million over the next eighteen months. It listed another fifteen deals under negotiation. If those came to fruition, revenues could eventually reach $1.5 billion, according to the PowerPoint presentation.
Mosley’s unease with all these claims had grown since that morning’s discovery. For one thing, in his eight months at Theranos, he’d never laid eyes on the pharmaceutical contracts. Every time he inquired about them, he was told they were “under legal review”.
Mosley was dubious given what he now knew. He brought up what Shaunak had told him about the investor demos. They should stop doing them if they weren’t completely real, he said. “We’ve been fooling investors. We can’t keep doing that.”
Elizabeth’s expression suddenly changed. Her cheerful demeanor of just moments ago vanished and gave way to a mask of hostility.
“Henry, you’re not a team player,” she said in an icy tone. “I think you should leave right now.”
There was no mistaking what had just happened. Elizabeth wasn’t merely asking him to get out of her office. She was telling him to leave the company—immediately. Mosley had just been fired.
My former company raked in venture capital money. It raised $20 million shortly before I joined, another $30 million about a year after I had joined, and yet another $40 million a year after that. With great funding came great responsibility. And our responsibility was to keep up, if not accelerate, our meteoric growth trajectory, as measured by leads, conversions, active users, subscriptions, and ultimately revenue.
I remember chatting with someone we had hired for this purpose, a “Senior Marketing Manager” who was eventually promoted to “Director of Growth Marketing”. He was in charge of paid advertising, which, in our case, was done primarily through Facebook. He would decide which “audiences” to target on Facebook, how the advertising campaigns were structured, and how much money to throw at each of them: in short, how to twiddle the various knobs that Facebook provides. Talking to him did not inspire confidence: not that he didn’t know what he was doing, but that what he was doing was even knowable. Facebook’s algorithm was opaque and fickle. The strategies that would work one week might not the next. And the entire process seemed more akin to alchemy than science: the right mix of ad set, audience, budget, and timing would produce gold, but it was difficult to know, before the fact, whether the mixture of ingredients would work, and, even after the fact, why it did (or, more likely, did not).
Nevertheless, he gained traction. At one town hall, shortly after his arrival, he was given an award for his contributions to the company. He had “unlocked” Facebook, we were told, which would bring in thousands more customers per month than we would have otherwise. He accepted the award almost sheepishly, and told me later, “When things are going great, it’s all your doing. When they aren’t, it’s all your fault.” He seemed to be waiting for the latter to occur.
And, it did. Before we get there, though, it’s worth quoting Paul Graham, creator of the startup “incubator” YCombinator (YC) and one of the most famous and successful figures in the startup community:
A startup is a company designed to grow fast. Being newly founded does not in itself make a company a startup. Nor is it necessary for a startup to work on technology, or take venture funding, or have some sort of “exit.” The only essential thing is growth. Everything else we associate with startups follows from growth.
When I first meet founders and ask what their growth rate is, sometimes they tell me “we get about a hundred new customers a month.” That’s not a rate. What matters is not the absolute number of new customers, but the ratio of new customers to existing ones. If you’re really getting a constant number of new customers every month, you’re in trouble, because that means your growth rate is decreasing.
A good growth rate during YC is 5-7% a week. If you can hit 10% a week you’re doing exceptionally well. If you can only manage 1%, it’s a sign you haven’t yet figured out what you’re doing.
We usually advise startups to pick a growth rate they think they can hit, and then just try to hit it every week. The key word here is “just.” If they decide to grow at 7% a week and they hit that number, they’re successful for that week. There’s nothing more they need to do. But if they don’t hit it, they’ve failed in the only thing that mattered, and should be correspondingly alarmed.
Focusing on hitting a growth rate reduces the otherwise bewilderingly multifarious problem of starting a startup to a single problem. You can use that target growth rate to make all your decisions for you; anything that gets you the growth you need is ipso facto right. Should you spend two days at a conference? Should you hire another programmer? Should you focus more on marketing? Should you spend time courting some big customer? Should you add x feature? Whatever gets you your target growth rate.
There are some obvious and disturbing implications of this ideology of growth uber alles. And they are reflected in the story of Theranos, quoted at the top of this essay, in the story of my old company, and, I’d argue, in those of most startups today. If the only goal is to grow, and if the people giving you money are evaluating you based on that goal, then there are very strong incentives to meet that goal at the expense of everything else. Our founders would make projections to our board, showing a line, representing customers (or subscriptions or revenue), curving upward, geometrically. Hidden within that line was a set of assumptions about our business: that, as Graham explained, we would acquire not just a constant number of customers per month, but that that number would increase over time. The projections placed demands on other parts of the business, and especially on my friend, the Director of Growth Marketing. If our retention of existing customers was unusually poor in that month, he was expected to make up the shortfall by juicing Facebook spending: acquiring new customers to replace the ones who’d cancelled. If he failed to hit an acquisition target in a particular week, the deficit would be rolled over to the next one. Projections were revised downward only reluctantly, if ever; a better solution, in the eyes of the founders, was to simply throw more money at the problem. (Remember, “anything that gets you the growth you need is ipso facto right.”)
It was not obvious to me at the outset, but spending money on advertising, like most other expenditures, has diminishing returns. There were only so many people in a demographic that would be interested in our product in the first place, and, as we scraped the bottom of that barrel, our costs rose even faster than the geometric growth expected from Paul Graham’s dictum. The math was stark: the number of customers cancelling was proportional to the size of the business; the number of customers needed to fill their places was also proportional; the number of customers on top of those who had to be acquired to maintain our 10% per month growth rate (which Graham himself would likely denigrate as being too low) was also proportional, and the costs per acquired customer were also rising. At its peak, our spending on Facebook was on the order of millions of dollars per week, which is a good way to eat through the (impressive sounding) $90 million raised from venture capital.
Theranos was confronted by the same predicament: a revenue curve that had to stretch inexorably upward regardless of the underlying realities of the business. Its problems were seemingly more fundamental than ours: namely, a technology that didn’t work. Elizabeth Holmes finessed the problem by simply making the numbers up and firing anyone who disagreed with her. We would like to think of Theranos as a special case. But I’d argue that this kind of fraud and deception is endemic to startup culture, or really any culture that places such an emphasis on growth. Is it not also fraudulent and deceptive to build a company around a paid acquisition strategy that is inherently unsustainable? Or one where you lose money on each customer? “Fooling investors”, what Henry Mosley complained to Elizabeth Holmes about, is all too common—mostly because investors now expect billion dollar ideas, of which real ones are vanishingly rare.
The problem with Theranos was that when the goal of a startup, codified by Paul Graham, conflicted with its realities, the goal won. The same was true for us, and for many other companies. In the startup mentality, failing to grow at the desired rates means dying. And a founder, the type of person who has attended all the right schools and gotten all the right degrees and therefore expects success, will do anything to prevent that from happening.
A lot falls by the wayside when growth drives decision-making. Problems with growth can be masked by promotions and discounts: they attract poor-quality, fickle customers who will eventually drop off, but they provide the temporary bump needed to hit monthly targets. Growth of customers requires growth of many other parts of the business: customer service, engineering, creative, etc. It is not easy to scale these divisions while maintaining high quality of work, and a healthy, diverse, cohesive culture. I remember our Director of Engineering being given a growth target of her own: to double the headcount of the team. The people she brought in were all white, male, startup bros, an endless stream of Justins wearing J Crew. Sustaining growth also causes constant tumult. When we’d miss projections, we’d change the roadmap and strategy. Those changes cascaded downwards: reorganizations of teams, hiring of freelancers, outsourcing to vendors, tighter deadlines, longer hours, less exciting work, and decreased morale. And the cycle would repeat when the latest and greatest strategy didn’t succeed. Eventually, our most talented and business savvy employees realized what was happening, and headed for the exits.
There is an alternative. One business owner I respect, David Heinemeier Hansson (DHH), wrote about his philosophy for building his company, Basecamp. (I hope you’ll forgive the prose that reads like a slightly better-read LinkedIn bro.)
For us, at Basecamp, it meant starting up Basecamp as a side business. Patiently waiting over a year until it could pay our modest salaries before going full time on the venture. It meant slowly growing an audience, rather than attempting to buy it, in order to have someone to sell to.
By prevailing startup mythology, that meant we probably weren’t even ever really a startup! There were no plans for world domination, complete capture of market and customers. Certainly, there were none of the traditional milestones to celebrate. No series A funding. No IPO plans. No acquisitions.
Our definition of winning didn’t even include establishing that hallowed sanctity of the natural monopoly! We didn’t win by eradicating the competition. By sabotaging their rides, poaching their employees, or spending the most money in the shortest amount of time… We prospered in an AND world, not an OR world. We could succeed AND others could succeed.
All this may sound soft, like we have a lack of aspiration. I like to call it modest. Realistic. Achievable. It’s a designed experience and a deliberate pursuit that recognizes the extremely diminishing returns of life, love, and meaning beyond a certain level of financial success. In fact, not only diminishing, but negative returns for a lot of people.
It would require difficult and disruptive changes to transform the startup economy in the way that DHH envisions. It would require that Basecamp be not just an isolated example but instead a template for new businesses. But the benefits, I believe, would be immense: an economy without such a stark division between “winners” (Facebook, Google, etc.) and “losers”; one where frauds like Theranos would be less likely to thrive, and one where friends like mine would not receive a company award one year and leave unceremoniously the next.
2 thoughts on “On growth and sustainability”