Startup: Redefined

This essay revisits the concept of startups—how they operate, why they are problematic, and what a better path forward might look like. Think of this as a subjective rant rather than a formal empirical analysis, drawn from my personal experiences as a software developer for almost six years and a student majoring in economics. Don’t expect rigorous data or academic citations; this is simply a reflection on what I’ve seen and learned over the past few years.

The definition of a startup itself went through many revisions over the last decades. In the late 90s, having a .com website was enough to earn the “startup” label. Since the early 2000s, however, the definition gradually shifted towards a tech company with unlimited scale potential—the ability to grow their user base by 1000% without proportional increase in their costs. This definition remains dominant, even after the COVID-19 pandemic.

Because many believe in this potential, venture capitalists (VC) and angel investors pour enormous sums into startups, despite the fact that 90% of startups fail, often operating with negative profits and cash flows. By investing in hundreds—perhaps even thousands—of startups, they hope one of them will be the next Facebook or Google. Even if 99% of their investments go to garbage disposals, one “unicorn” can offset the losses of an entire portfolio of failed ventures.

This changes the way we should think about startups. Startups are not companies that sell products or services like software or advertising platforms, the startup itself is the product! Economics textbooks often describe firms (except banks) as economic agents that maximize profit by allocating labor and capital to generate revenue. Startups clearly do not behave this way, but venture capitalists and angel investors do! They manufacture startups and sell them to less sophisticated investors at higher prices, all while crafting narratives of astronomical future returns. Their ownership of startups is not so much an investment as it is a cost of goods sold. On the flip side, the capital raised from other investors for VC funds should be considered revenue on the VCs’ income statement, rather than equity or liabilities on their balance sheet.

However, it doesn’t have to be this way. Many tech companies have been found successful without outside capital. One example is the 37signals who built several famously profitable products including Basecamp. They started as a design consulting company and evolved into a multimillion-dollar business without significant outside funding, aside from a minor, non-controlling stake sold to Jeff Bezos in 2006. Similarly, Mailchimp began as a small side project and grew into a multibillion-dollar company before its acquisition by Intuit in 2021 for $12 billion. For comparison, Facebook acquired Instagram for $1 billion just nine years earlier. Mailchimp’s story represents the largest exit for a bootstrapped startup to date.

Startups should focus on profitability, as Milton Friedman put it “The social responsibility of business is to increase profits.” Companies that earn the money they spend have less incentives to allocate resources inefficiently. On the other hand, giving millions of dollars to an unprofitable business model should be considered as a plain stupid—perhaps even fraudulent—investment. No wonder if the founders spend it recklessly; investing in technologies that won’t pay off, hiring workers they don’t need, and spending obnoxiously on marketing to acquire unloyal, discount-dependent customers. Startups claim to “disrupt” inefficiencies but often perpetuate their own inefficiency by burning cash.

Institutional investors, on the other hand, must step away from selling companies and misleading retail investors. Not only did they promote false narratives that burning cash is okay as long as you’re acquiring customers, but they also invented imaginary metrics like gross merchandise value (GMV) and total addressable market (TAM) to justify astronomical valuation. These institutions have caused too much trouble in our financial system and the startup bubbles are just the tip of the iceberg. The collapse of WeWork and many others have given enough cautionary tales. Yet regulatory frameworks haven’t kept pace. The fact that the Indonesian stock exchange allowed GoTo to IPO despite running tens of trillions of rupiah in losses is a major setback. Now, the stock has lost over 80% of its value since its IPO, mostly affecting retail investors, while the founders dumped their stocks and laid off thousands of workers.

After all, the biggest issue here is that the problems I described above are not merely the cause of the “tech winter” that we experience today, but rather only symptoms of a much larger problem: over the past few decades, the Fed’s money printing machine has worked tirelessly to revive the U.S. economy from economic recessions, starting from the dot-com bubble in the early 2000s, the 2008 global financial crisis, and the COVID-19 pandemic. These series of events forced the U.S. government to keep interest rates artificially low, fueling the bubble to become bigger overtime. Although the bubble has not burst yet, as the AI frenzy still keeps the music playing, it won’t last for long. The cracks begin to show since the Fed started to raise interest rates back in March 2022 to tame inflation. Venture capitalists began to run out of cash and profitability is starting to replace the “growth-at-all-costs” narrative.

Nevertheless, startups should be the cornerstone of technological progress, but the way the game is currently played is still more like musical chairs. I’m not against innovation and risk-taking behavior, but I’m against, at worst, fraudulent investments and, at best, inefficient allocation of resources. We need to reshape the way we think about startups, focus on long-term profitability rather than short-term growth figures, and tighten the regulation in financial markets.

Tags: Startup, Venturecapital, Economics