Structural Jenga in the Startup Jungle

(Aditi’s Note: For those not familiar with Jenga, it’s a game where players take turns removing one block at a time from a tower made of 54 wooden blocks. Each block removed is then placed on top of the tower, making it progressively taller and less stable. The game continues until the tower finally collapses.) 

In the “Startup Jungle”, akin to “Jenga” we’re all left managing the delicate balance of prioritising long-term value creation over short-term gains, carefully considering the implications of each investment decision for the overall stability and success of the venture capital firm, and, focusing on strategic decision-making required to navigate the unpredictable terrain of the startup ecosystem. 

However, one of the central problems evolves from the “principal-agent problem” within the startup ecosystem. In this scenario, what is the “principal-agent” problem? 

• Employees, generally everyone below the Partner level who doesn’t earn/earns a minimal share of carry (agents) of a venture capital firm are driven by incentives set by their LPs (principals), leading them to prioritise deals that will be driven by short-term gains, rather than focusing on long-term strategic investments. 

• This can lead to the venture capital fund’s portfolios lacking long-term resilience, and often failing to generate the expected returns needed to sustain and grow the venture capital firm. 

So, rather than focusing on mapping the exit roadmaps of their portfolio companies, understanding the long term marco-economic scenarios which affects not just how they plan to recover the capital they’ve invested, but how they plan to earn a RoI (Return on investment), that far exceeds your average indices; they end up focusing on “hot sectors” versus on promising long-term prospects underscoring the tension between immediate gratification, and, sustainable growth. 

How does this, in turn, lead to structural instability?

A venture capital firm begins by raising a starter fund/their first fund, and, given that they’re the newest fund on the block, if they’re unable to garner a particular MoIC (Multiple on Invested Capital), and/or RoI (Return on Investment), they’re unable to raise additional funds post their starter fund/first fund.

This leads to their corpus decaying over time, and, ultimately making the venture capital firm subject to how those particular “hot sectors/sub-sectors” they’ve invested in will perform over a period of time, and more often than not, resulting in “burnt capital” that the fund is forced to write off.

However, could this be a hidden positive?

In words of Yuval Noah Harari “There is some evidence that the size of the average Sapiens brain has actually decreased since the age of foraging. Survival in that era required super mental abilities from everyone. When agriculture and industry came along people could increasingly rely on the skills of others for survival, and new ‘niches for imbeciles’ were opened up.” We’ve seen startups that are forced to forage pushing themselves and excelling at innovation and execution, if for nothing more than the “need to survive” as Mr. Harari puts it.

Could this decline in funding in the venture capital ecosystem play devil’s advocate by forcing startups to be more frugal, deadpooling the one’s that are simply burning working capital, and bringing to the fore the one’s that continue to do more with less (resources, personnel, etc)? Could efficiency be the key metric that results as these startups continue to scale with less funding on hand?

A prime example of this is EdTech, a sector which was everyone’s darling a couple of years ago, and remains an essential sector of investment in a country of 1.44 billion, with the highest population of illiterate adults, at 23%, according to Unesco’s Education for All (EFA) Global Monitoring report.

However, EdTech is now the social pariah of the Indian Startup Jungle, especially post the EdTech sector “unicorn” BYJU’s fall from grace. We had initially begun to correlate BYJU’s astonishing rise in valuation to $22 billion in 2022 with it’s “success”, but the company saw an Icarus-esque fall in the months that followed with an erosion in value of $21 billion, bringing its current valuation to $1 billion as of January 12th, 2024. (BYJU’s has raised total funding of $5.08 billion to date.)

And, that my readers is how the tower begins to collapse, where each decision made affects the stability of your entire structure, making it essential to thoughtfully navigate the many challenges and complexities inherent to the “Startup Jungle”.