Raising millions of dollars from VCs is still the tech entrepreneurs’ dream. Entrepreneurs believe that a hoard of cash in the bank will give them the luxury of developing better products, marketing the heck out of them, and reaping the rewards with big sales and an eventual IPO. But more often than not, the money is a curse. When a company is running on a tight budget, it will usually perform far better than a company that is well capitalized. In my experience, having too much money always leads to bad habits.
First, the CEO will feel pressure from investors to upgrade the management team and bring in “grown up” supervision. This doesn’t always work out as planned. Seasoned managers want bigger salaries and larger chunks of equity. VCs usually expect a portfolio company to use a preferred headhunter to find the rockstar VP of sales. Naturally, the headhunter also wants an equity stake, on top of a finder’s fee in the neighborhood of six figures.
When the rockstar manager arrives, often coming from a big company, he/she may expect rockstar perks—a secretary, first-class travel, a limo to the airport, etc. These factors can serve to disrupt what must be the core focus of any startup—pulling in revenues as quickly as possible to forestall death. When employees see their bosses spending freely, they too stop worrying about keeping costs down and don’t care as much if a sales cycle stretched out longer. This attitude can kill a company.
Second, outside money usually brings expectations of very rapid growth and a de-emphasis on profitability. VCs wants a home run, not a single or a double. And they want the home run within five years or less. Founders, not VCs, know the proper pace of growth for a company. And a founder is far more likely to drive a company toward profitability if he’s is about to lose his life’s savings. A founder in this position turns every person in the company into a salesperson, and that’s the best model for a scrappy startup. In the end, this creates a company DNA emphasizing profitability above all else. That’s critical for success.
This happened in both of my startups. When my company accepted outside money, I immediately saw in board meetings and in company decisions that the focus was on growing revenues quickly but not necessarily sustainably. It was harder to maintain customer relationships built on trust when we also faced expectations to sell as much product as possible as quickly as possible, regardless of customer needs. Yes, sales guys should be hungry. But they should also have a long-term view on customer relationships and focus on profits rather than on top-line growth.
Third, outside money means that management itself spends less time thinking about customers and more time thinking about keeping the board of directors happy. Founding management is invariably far closer to the customers than the board is. And the more time and focus management can direct toward customers, the better. The outside money blurs the perception of who pays the bills. In the short run, that may actually be the VCs who have just sunk a chunk into the company. But in the long run, it’s always the customers.
This was exactly my experience as a startup CEO. As soon as venture money came in, I began spending significant amounts of time worrying about justifying my actions or framing my decisions to gain the support of the board. Pleasing board members became an unnecessary priority. That made it harder for me to focus on pleasing my customers.
Academic research also shows that undercapitalization isn’t necessarily a bad thing for startups. Professors David Townsend of NC State University and Lowell Busenitz of University of Oklahoma studied 79 companies that were funded during a 10-year period. They found, not surprisingly, that the combination of strong management teams with strong technologies correlated with success. But moderate levels of undercapitalization—even capitalization ratios as low as 20% of the venture’s initial goals—are not statistically related to a venture’s probability of surviving.
So, are rockstar management teams, boards, and VCs bad? By no means am I suggesting this. They can all be huge assets and major contributors to your success. And sometimes big capital is required for fast growth. In startups that actually need to produce a physical good, a huge capital ramp is usually necessary to get the factories rolling, even if they are on a contract basis. Bringing in rockstar management can make it easier to raise capital, for example, when the company is truly running on fumes and is almost out of options.
The point is that money by itself won’t make you successful; it may well cause you to fail. I will take an inexperienced, hungry, cash-strapped startup team over a well-oiled team of Google or Microsoft veterans any day. Hungry companies figure out ways to keep eating because they don’t know whether there will ever be another meal. Veterans and serialists worry less about failure and are therefore more likely to fail. This, in a nutshell, is why it’s so hard to find examples of people who have grown more than one company to considerable size. And this is also why less money means more chances for success at most startups. Capital starvation leads to innovation. Slim bank accounts are the best way to motivate sales people. So don’t worry if you think you don’t have enough capital. Instead, be grateful for your sense of urgency.