Continuing the thought on testing ideas in the marketplace…

Startups and venture capital are all about creating change.

A startup typically creates or requires some fundamental change to succeed: change in technology, economics, marketplace, changing consumer behavior, changing management, or perhaps just a change in customer, supplier, vendor, manufacturer.

Sometimes it’s disruptive, sometimes it’s not: but by nature the value is created through change.

At the same time, since most change doesn’t happen in the way we think it will, most companies fail.

Given the difficulty in predicting the outcome of change it’s pretty obvious why venture capitalists diversify their investments and stage their investments. The basic hit-driven nature of venture capital and startups is the foundation of the economic model and entrepreneurial culture.

But why do the vast majority of new businesses fail? Why do venture capital firms have to depend on hits to create the returns necessary to pay back the losses on the vast majority of their bets? Is it because the system forces entrepreneurs to decide and focus too early?

Think of starting a company as a way to test an idea in the marketplace. Testing an idea is a way of creating a real option; by making small investments (in money, time, passion, intellect) in hashing out ideas we are creating options for future, larger investments in the winning ideas. Real value is created in testing even if it does not see the marketplace, if for no other reason than it mitigates value at risk.

Of course traditional venture capital is based on this stage-gate approach, using the value of time and information to help them make decisions on investing further money and time in companies in follow-on investment rounds. But maybe the first gate requires too many decisions, too many lines drawn in the sand? Perhaps early-stage investors require entrepreneurs to decide on too much too early, restricting what is being tested and limiting the opportunities for adaptation and evolvement. Entrepreneurs can test ideas with self-funding (bootstrapping), but it’s a step few entrepreneurs really understand.

Can we create a system that allows entrepreneurs to test even more?

Can we increase the amount of ideas that get tested, but decrease the amount of businesses that fail?