Earlier this year, in the first quarter, VC spending hit its highest point since 2001, with $10 billion across 888 deals. Anand Sanwal, CEO and Co-Founder of venture capital database CB Insights, said it best when he called the landscape “frothy.” The nine-figure “mega-round” is “happening so frequently,” he added.
As a result, today, startup funding is like politics. It’s an unending horse race, with the more capital you raise an indication of how successful you’re supposed to be. Ultimately, funding, rather than product, is being glorified.
This is a dangerous thing for startups. Don’t get me wrong—capital is great. It facilitates growth. And in some ways, it validates your business. But the way we position it today, as the definition of success, has created an environment where startups are chasing money too early. They want it before they’ve even launched.
Here’s why that’s a bad thing.
1. You lose equity
Let’s start with the obvious. As anyone who has seen The Social Network knows, when you fundraise through a third-party, you inevitably lose a percentage of your company. Over time, the dilution can be offset by the increased valuation, assuming the business continues to perform well with each round.
Still, avoiding dilution early on – unless absolutely needed – is the best option. Bootstrapping is always preferable, as it will enable you to hold on to equity for a longer period of time (which is the real goal). To sustain your startup without outside funding, it’s important to strictly manage your burn rate. At my company, VMR, we achieve this by focusing resources and capital on the core areas of our business. For non-essential functions, we’ll bring in partners to plug gaps.
2. You lose control
Remember, dilution and leverage (not debt, but the power to influence) are directly related. As one goes, so does the other. Accepting an outside investment essentially anchors you to the financier’s perceived exit strategy. They will want a return on their investment, so the exit – in some form – will be what you’re working towards, always.
And, at some point, these visions might conflict with one another. For instance, preferred investors can leverage protective provisions to withhold an acquisition, even if you – management – think it’s the best play. Or, alternatively, investors can encourage a sale of your business, even if you disagree. This is the bargain you commit to when raising outside money. Your company’s long-term destiny can change.
A great example is AOL. In 1991, CompuServe nearly acquired AOL. Investors wanted the deal. Luckily for them, it didn’t happen. AOL become a billion dollar business and, instead, bought CompuServe.
3. You scale too soon
With an influx of cash comes the desire to scale. You want to hire great people, expand into new markets, and, to put it simply, grow (this is partly driven by your investor’s desires). But by spending lavishly on growth, startups can often forget to invest in the most critical area—their product.
Clinkle is a prototypical example. They landed $25 million from Sir Richard Branson without having launched anything. Their app was actually being developed “in secret” at the time of their capital raise. Without having brought a product to market, Clinkle ended up spending cash on a commercial, on a staff of 60, which included an in-house PR rep, and more. All of this was wholly frivolous, especially when you consider that it took Clinkle three years to develop an actual product.
4. Your culture suffers
The best way for a startup to evolve is to be challenged by a lack of resources. It forces you to think outside of the box and seek out solutions in the unexpected. This is why bootstrapping is the ultimate approach towards developing the ideal company culture. It makes a team smarter and more capable.
As an example, I launched VMR in 2009 with little capital, but a big idea. And rather than seek out funding, we obsessively managed what little capital we did have. We didn’t get an office, we worked out of an apartment. We only hired a handful of essential employees. We were forced to be better—and it worked. Today, we have a global manufacturing presence, nearly 200 employees and over 1 million customers. Without those challenging early experiences, I don’t think my team would have built what we have today.
To be clear, I’m definitely not knocking outside capital. It is an essential part of a company’s lifecycle, extending their runway to reach that next milestone. But, as a culture, technology startups need to stop chasing money out of the gate as a point of validation. Rather, focus on building something worthwhile on your own. Once you do that, investors will come to you.