About the question investors ask that startup founders hate the most

If you want to better understand how venture capitalists make decisions, follow ​Denis Kalyshkin and Ask VC​ on LinkedIn. I regularly run my “Venture Analyst” course there, answer questions, and analyze venture deals.

When I analyze a startup, I look at 20+ parameters. But there’s one question among them that annoys founders the most. Nevertheless, Y Combinator, Sequoia, and other top VCs ask it in one form or another. The question is: “Why can’t your startup be replicated? What is your unfair competitive advantage? Your secret sauce? Your barrier to entry?”

Even experienced founders will sometimes say in private conversations that this is complete nonsense. They claim that investors read a few articles online and now mindlessly ask this question. “What barrier to entry did Uber or Airbnb have?” an entrepreneur might say. And it’s true that not every investor can explain why this question matters. I’ll do that below. But in such cases, I usually respond with: “Do you know what the margins are in car sharing? And why?”

Before explaining why barriers to entry matter, let me give a vivid example. These days you often hear how Anthropic or OpenAI released another update and wiped out hundreds of startups. Previously, similar stories were about Google and Apple when they rolled out updates that killed the businesses of certain mobile apps. This is exactly the realization of risk associated with low barriers to entry.

Now, as promised, here’s why this question is important. You’ve probably heard about perfect competition and that it’s considered a good thing. Well, it’s good for the customer. For a business owner, it’s a disaster. Why?

In microeconomics, it’s shown that if your product or service is identical to what others offer, you lose the ability to influence price. As a result, your net profit goes to zero. This is even proven mathematically. Engineers would love it. When I first learned this in 2009, I couldn’t believe it. Then I started observing real small businesses in established industries with low barriers to entry and high competition. And indeed, their margins are 1%, 3%, 5%, and in rare cases 10–15%.

Without complex formulas, imagine you want to buy a Snickers. There are millions of stores where you can do that. Suppose you walk into one store and the price is twice as high as everywhere else. What do you do? You think they’re crazy and go to another store. As an old ad used to say: “If there’s no difference, why pay more?” Of course, there are edge cases. For example, if you’re in a remote area with only one store, prices might be twice as high. Take it or leave it. But that’s no longer a situation of perfect competition. It’s a local monopoly. In that case, the price is determined by the owner’s greed and the threshold at which locals might revolt.

The second factor that drives prices down when barriers to entry are low is your future competitors. Suppose you came up with an idea first and started making good money. You have strong margins, a queue of customers. Life is good. But it’s only a matter of time before one of your customers realizes how profitable and easy your business is to replicate. Then they decide to do the same. Now there are two of you. Then three. Then sixteen. Then sixteen thousand. With each new competitor, your margins shrink until you’re barely breaking even.

The easier your business is to replicate, the more people will try. And now, in the era of vibe coding and AI agents, every anyone can build a fairly complex product for $200. And if major players like Anthropic see that your niche is profitable and easy to dominate, they will absolutely move in and crush weaker competitors.

So your real defense is having a barrier to entry that allows you to maintain high margins and deter others. And often, that barrier is not purely technological. Any solution can be replicated. One can replicate even Elon Musk’s Starship. The question is how much time, money, and resources it takes. By the way, there are 120+ startups building rockets for space launches. But most of them struggle to raise funding precisely because investors see the high barrier to entry and the hopelessness of competing with Elon Musk. And without significant capital, you simply can’t build a rocket.

What’s the practical takeaway for a startup founder? Yes, your first MVP can often be replicated quickly because you probably built it over a weekend yourself. The key is to answer what you will do over the next 1–3 years to make your product hard to replicate. Otherwise, sooner or later, you’ll face dozens or even hundreds of competitors.

To wrap up, here’s an example from a partner at a venture fund with dozens of unicorns in its portfolio. In 2024, he was actively investing in AI. When he backed a startup at the pre-seed stage, it had no competitors. One year later, when it needed to raise a seed round, it already had 50 competitors. How do you choose the one that will become the category leader?

Good luck building your business!