10 years ago Sequoia dropped the ever so legendary RIP Good Times, and it’s fair to say that as of mid 2018 we’re back in Good Times. 💃 There is an incredible amount of active institutional investors and angels in the market, and new funds still keep on popping up left and right. “This is not normal” but as the competition among investors increases, we are starting to see funding rounds and valuations move north. The seed round which used to be $1m is now $2, and an A round which used to be $3–5m is now $7–10m. A similar relative trend can also be seen in pre-money valuations. Thus, for founders who know how to play the VC game, it has never been a better time to get funded.
In this post I want to share a bit of caution related to this. With my own previous company we raised too much money too fast. Only 8 months after founding the company we had raised $10.5m, and 15 months later an additional $15m. More money isn’t necessarily always better. Capitalizing your company too fast and too much can have dire consequences in the short to mid-term, dramatically impacting strategic decisioning, behaviors and culture. Long term, you also have to live up to any hefty amounts of money at lofty valuations and markets change so be ready to for that. The current environment is not normal and the market will adjust.
A key to why startups are able to better than industry incumbents to innovate is because of scarcity. Fewer resources at hand means you have to focus and do fewer things. It also fosters a critical creativity around problem solving. If you are constrained by the amount of money you have to spend you simply force yourself to do things differently. That’s where true magic is created.
When my startup suddenly woke up one day with a massive amount of money on our balance sheet, the fabric and DNA of our company changed. We were no longer forced to be as innovative and creative. We could solve some of our problems by spending money. As an example we started using various agencies to help us with marketing. That seemed to be the reasonable thing to do to get attention. And we could afford it so why not? If we had been more constrained with our finances we wouldn’t even have been able to consider such a thing. If you can’t buy TV ad to reach your customers, instead you may create cereal boxes which becomes the talk of town and generates massive attention. That’s the magical problem solving which is so valuable when used in the right way. With too much funding, a company have to work much harder in maintaining such a creative mentality. And without the creativity and innovation, you will not make it.
More money simply means higher spend. Not only is money used to solve problems, as mentioned above, but also pure operationally. Team members will question why they would be paid less than market salary if the company has a massive balance sheet. You will have less leverage using equity incentives, and salaries will go up. The small office you work out of which previously felt uniquely cool, is suddenly perceived as cheap and you’ll have to upgrade. Instead of the standard Dell monitors people expect retina Apple displays. It’s only another hundred bucks more here and there, and if you have millions in the bank account what does it matter? It happens gradually and with small steps. It’s not because people are reckless or greedy. It’s just simple psychology. You may be able to manage parts of this with hacks like using old doors as desks but needless to say it becomes difficult to maintain a lean spend mentality when the company is well funded.
It’s also important to mention that moving up in spend and comfort in an organization is very easy when you have the money. Most people are happy about it. But moving the other way, in case the business need to scale back on spend is much more difficult. Just think about the atmosphere in the office after you ask your staff to take a salary cut because you need to bring burn down. 💩 always happens in startups and plans are rarely perfect. Be ready to tackle this unknown by managing your spend extremely wisely.
Take my word for it — do not scale up your business until you know you have confirmed product-market-fit and unit economics! When Rocket Internet launched a clone of Wrapp we chose to fight them across the world. We started expanding into 18 (!) markets across the world in parallel. This was when the company was still less than 1 year old. We did it because we had the financial resources to do so. If our war chest wouldn’t have been so large, we would have been forced to prioritize harder. In such alternative world we would perhaps only have expanded into one international market outside of Sweden where we started. But such expansion would have been done with more diligence and focus, and the faith of the company could have been dramatically different.
It’s definitely fair to say that at the time, we were not ready to scale up. We hadn’t fully figure out our sales process, our product still had a much to wish for, and most importantly our organization was very immature. We hadn’t found our culture and identity as a team, and we didn’t know whom and how to hire “the Wrapp way”. This was a critical mistake which had an instrumental impact on team dynamics and spirit when we suddenly grew from 10 to 100 people across the world. We should have forced ourselves to slam on the brakes and play more cautiously. Money provides you with the fuel needed to increase speed, but don’t kid yourself to speed up until you are truly ready for it.
With a comfortable balance sheet to support your operations, a company can easily convince itself that the importance of revenue is not as urgent. Once you reach scale or have proven the product’s value you can start charging for it. It’s one of the reasons VCs exists, so I’m not at all fundamentally against this mentality. Free trials, freemium experiences and signup bonuses are successful tactics to use. But over and over again we see companies who are unfortunately too confident they can figure out the business model at a later stage, and instead use external financing to subsidize its product to users. There are, for example, many startups’ skeletons from the on-demand economy who pushed aggressively into the market with negative units but ultimately faced the unavoidable destiny.
We did this mistake at Wrapp as well where we allowed many retail clients heavy discounts and sometimes even free access to our marketing platform. We thought this was the way to do it because we could get more of the clients to try our service, and we had enough funding to support such an effort. Of course, at the time when it came to convert these clients to paying users we stumbled upon plenty of obstacles. Our sales process was simply broken but we didn’t realize until too late since we didn’t even try to charge for it. Don’t let heavy funding mistake yourself from focus on unit economics. Never let go of proving your business model even if you today don’t need the revenue to survive. Ultimately all successful companies generate money. You should to.
A final thing to mention is that any financing rounds for early stage companies implicitly give the company 12–24 months of runway. When you close a financing round you start working against the clock in order to get your company to the next level and achieve the financing milestones. And the funds you have raised are not to be put into a savings account; you are expected to use the funds during this timeframe. How do you ensure that you can put every dollar raised to use and make that one dollar into many more dollars? You only have 12–24 months to figure it out.
So in 2018 when money is cheap, how should you raise funding for your company? You can’t shoot in the dark. If you don’t realistically have a plan on how to use the funds, think twice even if you’re offered more money. Of course you need a cushion in case of the unknown, but be rational. If you believe $5m is needed to execute your 18 month plan, perhaps you raise $6m to give you some buffer. But if your plan justifies $5m, perhaps it’s unwise to raise $10m. Don’t let ego and vanity of large financing rounds guide you. Raise the money you need to accomplish your milestones. These Good Times are enjoyable but they will not last. Make sure your company does as well.
Rock on! 💪👊
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