The test of any investment is the ratio of return to risk. Startups pass that test because although they're appallingly risky, the returns when they do succeed are so high. But that's not the only reason investors like startups. An ordinary slower-growing business might have just as good a ratio of return to risk if both were lower. So why are VCs interested only in high-growth companies? The reason is that they get paid by getting their capital back, ideally after the startup IPOs, or failing that when it's acquired.

Why VCs Love Unicorns

It might seem that it would always be better to start a startup than an ordinary business. If you're going to start a company, why not start the type with the most potential? The catch is that this is a (fairly) efficient market. If you write software to teach Tibetan to Hungarians, you won't have much competition. If you write software to teach English to Chinese speakers, you'll face ferocious competition, precisely because that's such a larger prize.

Ideas

If you want to understand startups, understand growth. Growth drives everything in this world. Growth is why startups usually work on technology — because ideas for fast-growing companies are so rare that the best way to find new ones is to discover those recently made viable by change, and technology is the best source of rapid change.Growth makes successful companies so valuable that the expected value is high even though the risk is too. Growth is why VCs want to invest in startups.

Understand Growth

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.  Startups are so hard that you can't be pointed off to the side and hope to succeed. You have to know that growth is what you're after. The good news is, that if you get growth, everything else tends to fall into place. This means you can use growth like a compass to make almost every decision you face.

Startup: A Primer

Considering how valuable a successful startup can become, anyone familiar with the concept of expected value would be surprised if the failure rate weren't high.

The real question is not what growth rate makes a company a startup, but what growth rate successful startups tend to have.The growth story has three phases:<ul><li>There's an initial period of slow or no growth while the startup tries to figure out what it's doing.</li><li>As the startup figures out how to make something lots of people want and how to reach those people, there's a period of rapid growth.</li><li>Eventually, a successful startup will grow into a big company. Growth will slow, partly due to internal limits and partly because the company is starting to bump up against the limits of the markets it serves.</li></ul>

Being On The Right Path

To grow rapidly, you need to make something you can sell to a big market. That's the difference between Google and a barbershop. A barbershop doesn't scale.For a company to grow really big, it must (a) make something lots of people want, and (b) reach and serve all those people. Barbershops are doing fine in the (a) department. Almost everyone needs their hair cut. The problem for a barbershop, as for any retail establishment, is (b). A barbershop serves customers in person, and few will travel far for a haircut. And even if they did, the barbershop couldn't accommodate them.

Scalability

Starting a startup is thus very much like deciding to be a research scientist: you're not committing to solve any specific problem; you don't know for sure which problems are soluble, but you're committing to try to discover something no one knew before. A startup founder is in effect an economic research scientist. Most don't discover anything that remarkable, but some discover relativity.

The Bottom Line

Larry Page and Sergey Brin wanted to search the web. But unlike most people they had the technical expertise both to notice that existing search engines were not as good as they could be, and to know how to improve them. Over the next few years, their problem became everyone's problem, as the web grew to a size where you didn't have to be a picky search expert to notice the old algorithms weren't good enough. But as happened with Apple, by the time everyone else realized how important search was, Google was entrenched.

Solving Our Own Problem

A company that grows at 1% a week will grow 1.7x a year, whereas a company that grows at 5% a week will grow 12.6x. A company making $1000 a month (a typical number early in YC) and growing at 1% a week will 4 years later be making $7900 a month, which is less than a good programmer makes in salary in Silicon Valley. A startup that grows at 5% a week will in 4 years be making $25 million a month.Our intuitions are no guide here. What happens to fast-growing startups tends to surprise even the founders.

Compounding Growth

That's one connection between startup ideas and technology. Rapid change in one area uncovers big, soluble problems in other areas. Sometimes the changes are advances, and what they change is solubility. That was the kind of change that yielded Apple; advances in chip technology finally let Steve Wozniak design a computer he could afford. But in Google's case, the most important change was the growth of the web. What changed there was not solubility but bigness.

The Importance Of Technology Advancement

The fascinating thing about optimizing for growth is that it can actually discover startup ideas. You can use the need for growth as a form of evolutionary pressure. If you start out with some initial plan and modify it as necessary to keep hitting, say, 10% weekly growth, you may end up with a quite different company than you meant to start. But anything that grows consistently at 10% a week is almost certainly a better idea than you started with.The constraint of growing at a certain rate can help define a startup.

Growth Works On Your Startup Pivoting

The reason VCs like to invest in startups is not simply the returns, but also because such investments are so easy to oversee. The founders can't enrich themselves without also enriching the investors. Why do founders want to take the VCs' money? Growth, again. The constraint between good ideas and growth operates in both directions. It's not merely that you need a scalable idea to grow. If you have such an idea and don't grow fast enough, competitors will. Growing too slowly is particularly dangerous in a business with network effects, which the best startups usually have to some degree.

Enriching The VCs

Almost every company needs some amount of funding to get started. But startups often raise money even when they are or could be profitable. It might seem foolish to sell stock in a profitable company for less than you think it will later be worth, but it's no more foolish than buying insurance. Fundamentally that's how the most successful startups view fundraising. They could grow the company on their own revenues, but the extra money and help supplied by VCs will let them grow even faster. Raising money lets you choose your growth rate.

Growth Is The Reason Startups Get Repeat Funding

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.

Don't Focus On Ten Things, Just One

The phase whose growth defines the startup is the second one, the ascent. Its length and slope determine how big the company will be.The slope is the company's growth rate. If there's one number every founder should always know, it's the company's growth rate. That's the measure of a startup. If you don't know that number, you don't even know if you're doing well or badly.

The S Curve

The best thing to measure the growth rate is revenue. The next best, for startups that aren't charging initially, is active users. That's a reasonable proxy for revenue growth because whenever the startup does start trying to make money, its revenues will probably be a constant multiple of active users

How To Measure Growth: The Best Indicators

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.Programmers will recognize what we're doing here. We're turning starting a startup into an optimization problem.

The Bottom Line

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