How Big VCs Have Ruined Software

Sean Stuart
6 min readNov 30, 2022


The worst kept secret in investing is that software companies are great businesses. While everyone knows that they are high margin, infinitely scalable, and iterative, they are also cheap to start, which is the part we seem to have forgotten.

Venture capital is to blame.

Record amounts of capital flowing into the industry through larger venture capital funds allowed these firms to inflate the size of fundraising rounds.

Deep tech companies have benefited immensely from the greater availability of capital.

Software companies have not.

Everyone loses. Software founders get diluted too much and become dependent on external capital. Employees are deceived by how much risk they are taking on. Investors get worse returns and customers often get a worse product.

More money = mo problems.

Note: This isn’t true if you don’t have enough money in the first place, a very real problem for Aussie pre-seed

In a utopia, funding for software companies would not be tied to artificial naming conventions. Pre-seed. Seed. Series A. These reflect nothing about the risk profile of these businesses.

There could be a software company with no revenue at Series A raising $15M while the seed company has $4M in revenue.

The relative risk of software companies can be calibrated and categorised. There are three key categories I have found to be useful:

  1. True product discovery
  2. True product market fit
  3. True go to market fit

Every successful company goes through each of these stages. Every unsuccessful company fails at one. While broad, these appear to be the best predictors of how ‘derisked’ a software business is and how much capital it actually needs. Importantly, these three states are even better predictors than top line revenue.

Traditional fundraising rounds are somewhat arbitrary in what defines a pre-seed or a seed round. Sometimes top line revenue is used to define the stage. But as we will explore, this is easily exploited and not indicative of the true state of the business.

There are many signs of this over funding in the tech world. Appointing a chief of staff role before there has been actual product discovery. Hiring 30+ employees before there is product market fit. Millions of dollars spent in unprofitable go-to-market channels.

And again, this has largely been the fault of venture capitalists as opposed to founders.

Pure software businesses should be one of the best risk-adjusted investments ever, as capital can be injected incrementally as an idea is de-risked. But they’re not.

Let’s lift the hood of each of these stages.

True product discovery

Essentially, this is the discovery of a true need or desire in the market that is experienced by a subset of customers and not being properly addressed.

It could be the discovery that Gen Z wants to communicate with their friends without having their data permanently stored on the internet (Snapchat).

True product discovery is rare. Almost every business will claim to have achieved it, but there are a myriad of traps in finding it. For a pre-seed software business, I would argue the main goal is achieving true product discovery. This can be done with a team of three or even a team of one. More importantly, I would argue that you don’t need any outside capital until there is evidence that this state has been achieved.

It seems the ingredients of true product discovery are:

  • Access to a large amount of target customers
  • Ability to extract unbiased insights about their needs and wants
  • Constant iteration to find or uncover key insights.

The easiest way for a VC to validate whether true discovery has been achieved is:

Ask the entrepreneur:

  1. Who is your target customer?
  2. What is their pain point or desire?
  3. Why are they under serviced currently?

Then ask target customers:

  1. Do you experience this pain point or desire?
  2. What do you currently use to solve it?

It sounds simple and it really is, being a VC is far easier than being a founder. Generally, when we ask these questions, we very rarely find true product discovery. Most of the time a problem is not really a problem people feel that strongly about.

But sometimes, you find a subset of people who want to stay on the call and tell you how much that problem pisses them off.

This is exciting and a great sign that a software company should raise money to deliver on their product discovery.

True Product Market Fit

Product market fit (PMF) is when you deliver a product that satisfies a need or want in the market.

Counterintuitively, you can have lots of revenue without achieving true PMF. This could be because you land a few large enterprise deals due to a great sales rep, but then no end users in the company use the product.

That’s why it’s common practice to measure true PMF by cohort retention — either by usage or revenue. Graphically, PMF looks something like this:

It shows that a subset of customers derives enough value from the product that they will continue to use it as time elapses. Product B in this example eventually has no users who signed up in Month 0 using the product after 20 months.

It is the gold standard for measuring true PMF in software businesses. Different types of software businesses will have different types of cohort data and ways of assessing it, but the principle is that the line needs to stabilise over time.

It’s possible to have true product discovery but then fail to deliver a product that has true product market fit. Customers just might not like the software.

At this stage, pouring more money into the problem is likely to have the opposite of the desired effect.

Matty Cagan, a world-renowned product expert, believes that at this stage you should have no more than a team of 12: one product manager/founder, one designer and between 2–10 engineers. This allows a startup to iterate quickly and ship product that eventually achieves PMF.

The sad reality is that many VCs at this stage care too much about revenue and not true PMF. I would argue that this is completely the wrong approach for software.

True Go to Market

This is the stage where you can pour gas on the fire. Once there is a product with true PMF and there is a scalable channel to reach as many of these types of target customer as possible, it’s time to scale.

How much money should be allocated is a function of these metrics:

  1. LTV/CAC > 3
  2. Payback period < 12 months
  3. Magic Number > 1.0

This metrics will steer the ship for how much money the business can afford to spend on growth. As long as growth can be sustainable, more venture capital money should be put to work.

Key takeaways

These three stages are very difficult to achieve. Hopefully, by guiding how much money you need based off of achieving them and the underlying metrics, we can de-risk software and not have any of the following:

  • Lots of people getting fired because a company goes under at Series A because it never had PMF
  • Founders feeling so much pressure to perform for the VC because there was never true product discovery
  • Investors loosing millions of dollars because they failed to realise that this is software and there are clear states of risk vs return.