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• Can Tax-Advantaged Capital Solve the Venture Parad …

My name is Gerry Hays, Founder & CEO of Doriot® (pronounced “Doe-ree-oh”), named after French-born American U.S. General Georges Doriot, the father of Venture Capital. I’m also an author (First Time Founders’s Equity Bible), inventor (U.S. patents for ads on t-shirts, coat checking, and VentureStaking - pending), and 21-year professor of venture capital and entrepreneurial finance at Indiana University.

Democratize Venture is my platform to explore the venture markets and share the insights, strategies, and frameworks I bring into the classroom. It’s also a way for me to share principles of prosperity — because at the end of the day, venture is a pathway to prosperity.

Can Tax-Advantaged Capital Solve the Venture Paradox?

There is a perception of how venture works, and then there is how it actually works. Silicon Valley created much of the modern venture playbook, and as Silicon Valley goes, most startup markets tend to follow. The problem is that most of the world is trying to play the same game without anything close to the same capital, networks or infrastructure.

And when I talk about venture, I'm talking about the very beginning. Before seed. Before there is really even a startup.

There is no organized, professional system for giving tens of thousands of capable people enough capital to search for a solution to a problem they're obsessed with. I call that Search.

Search is what happens before the company. Somebody sees a problem and needs time and capital to understand it at a first-principles level. They talk to people, test assumptions, build things, throw things away and maybe discover that what they originally thought was the answer wasn't the answer at all.

If you look at how this gets funded today, there are basically three ways it happens.

The first is signal. If you're high signal, you can get capital to search. Maybe you went to an elite university, already built a successful company, or you're part of the networks where people know you and capital moves. Investors are comfortable funding the person because they're betting that person will figure something out.

The second is traction. If you don't have enough signal, the market generally wants you to prove something first. Get customers. Show growth. Generate some MRR. The definition changes depending on the Investor, but the message is pretty consistent: show me that this works and then we can talk about capital.

That seems reasonable. An Investor wants evidence before taking risk. But think about the behavior it creates. If the way to get capital is to show a product and customers using it, we're encouraging the Founder to produce a solution. That's not necessarily the same thing as understanding the problem.

And I think that's a bug in the system.

At the beginning, the most valuable thing a Founder can do may be to forget about the solution for a while. Go live with the problem. Understand why it exists, how people currently deal with it and which assumptions are actually true.

But "I spent six months understanding this problem and discovered that half my assumptions were wrong" doesn't look like traction. A product does. Revenue does. So we encourage Founders to jump ahead: build something, find someone willing to use it and generate enough traction to raise capital.

The Founder may have traction, but do they actually understand the problem? Those aren't the same thing. Companies pivot for all sorts of reasons, but I suspect some pivots happen because capital was raised around a solution before the Founder understood the problem underneath it.

That's the Venture Paradox. The Founder needs capital to conduct the Search that can produce a meaningful solution, while the Investor wants evidence of the solution before providing the capital.

People will say bootstrap. Fine. But bootstrapping still requires money. It just means the money came from somewhere other than an Investor. If someone has enough savings to spend a year searching, they've solved the Search capital problem themselves. Most people can't do that.

The third way is narrative. Sometimes a problem is important enough that people are willing to fund the Search itself. Climate is a good example. Capital can arrive before traction because someone believes the problem itself is important enough to search for a solution.

So if you're starting something, it's useful to understand which bucket you're in: signal, traction or narrative.

There are, of course, institutions that understand the opportunity in funding people before there is a startup. Y Combinator is an extraordinary example. The Thiel Fellowship approached it differently. a16z and others have built programs and networks aimed at identifying people earlier.

And they kill it.

So this isn't an argument that venture doesn't know how to identify early talent. Some of its best institutions are exceptionally good at it. The problem is that most of the world doesn't have these institutions or anything close to Silicon Valley's capital.

Think about the NFL Draft. The first round is where the signal is strongest. There is film, statistics, scouting and interviews. YC is a little like that—an extraordinary selection system for identifying a small number of exceptionally promising people.

But the NFL Draft has seven rounds, followed by undrafted free agents. As you move down, there is less signal and more uncertainty. That doesn't mean there isn't talent. It means the talent is harder to identify.

Now imagine running that draft with a fraction of the scouting budget and almost no infrastructure for developing players who aren't already obvious. That's much closer to what early-stage venture looks like in much of the world.

These markets have inherited the same venture playbook—find signal, look for traction and invest—without Silicon Valley's concentration of capital, Angels, accelerators and repeat Founders. You can't play the same game with a fraction of the resources and expect the same outcome.

And here's the strange part: there isn't necessarily a shortage of capital in venture. There are billions of dollars waiting for companies with $10 million in ARR, strong growth, profitability or a clear path to it. Once enough signal exists, capital competes for the opportunity.

The scarcity is at the other end of the market, when someone understands an important problem but doesn't yet have a company, customers or revenue.

We have enormous amounts of capital waiting for the outcome, but very little organized capital willing to fund the Search that creates it.

Which brings us to the economic problem. Who pays for Search?

Traditional venture funds have LPs who expect financial returns. But if we're realistic about Search, the failure rate should be enormous. Nine out of ten Searches may produce nothing investable.

And that's okay. Someone might spend six months investigating a problem and discover there isn't a viable company there. That's useful information. In Search, discovering that something shouldn't become a company can be a successful outcome.

But that's a difficult portfolio to finance with traditional LP capital.

So maybe Search isn't investing. Maybe Search is philanthropy.

Today we tell aspiring Founders to find investment capital before they've necessarily created something investable. Then we're surprised when Investors ask for traction. But the Investor isn't doing anything wrong. We're asking investment capital to do a job it wasn't designed to do.

What if tax-advantaged philanthropic capital funded Search instead? Give capable people relatively small amounts of capital to investigate problems they're committed to solving. Let them test assumptions, be wrong, abandon bad ideas and generate information. The objective isn't financial return. It's discovery.

Then, when Search produces something interesting—a real problem, a credible solution, evidence of a market and a capable Founder—investment capital can enter. Now Angels, seed Investors and VCs have something to evaluate.

Perhaps tax-advantaged capital can solve the Venture Paradox by funding the part of entrepreneurship where traditional investment capital simply isn't a natural fit.

Search comes first. Investment comes when we discover something worth investing in.

Have a great weekend -gerry