Why the “raise as much as you can always” myth is so pervasive
Wednesday, July 8, 2015/
After announcing our first institutional round of funding for AffinityLive last week and highlighting why we deliberately raised a small round of capital, a number of entrepreneurs reached out asking the same basic question: Why is the belief that raising as much money as you can, any time you can, so pervasive?
While it is fair to say it’s often ego and pride (and a “pissing competition” in Aussie parlance) that makes entrepreneurs put their best interests to one side and raise all they can, the ego payoff wouldn’t be there for achieving “success” if it wasn’t such an article of faith. In this post, I try and get beyond the behaviour of the entrepreneurs responding to the desire for external validation and, instead, try and understand why raising as much as you can is validation at all.
All I can offer is one perspective, but as someone who’s been around the Silicon Valley scene for a number of years with many friends who are investors, service providers (landlords, attorneys, recruiters) and of course the media (I couch-surfed at Mike Arrington’s place back in the day, and MC’ed the TechCrunch Hackathon for a number of years), I hope this perspective is at least helpful in understanding the reason so many benefit from maintaining this belief – and it makes perfect sense if you think about the way these critical groups influence the narrative and behaviour of the startup ecosystem.
First of all, there are the investors, whose job is to invest other people’s money into successful startups for a great capital return. One of the big trends we’ve seen has been the dramatic rise in the size of the funds these investors are raising (or the total funds under management).
These investors are raising bigger and bigger funds for three reasons:
- Record low interest rates mean investors are increasingly looking to alternative asset classes (like venture investing) to try and make returns.
- The fundamentals of the tech sector mean the sector can offer great returns (fairly ubiquitous broadband in the developed world, smartphones in billions of pockets around the world – it isn’t wild or crazy to see more opportunity than risk).
- VC partners get paid around 2% a year to manage the funds they raise, and 20% of the gains they make for their investors, which incentivises them to get more money in and put more money to work – even if their investments are duds, 3x the funds under management means 3x the yearly salary, risk free.
The consequence of these bigger funds is they have to either write a lot more cheques per year (which requires more partners sharing the spoils, or the existing partners to work harder, neither appealing), or they write the same number of checks and just make them bigger checks. Whichever way they jump (and most opt for the later), the result is more money needing to be shovelled into startups – hence the desire to cultivate the belief that raising more money is always better.
There’s a saying that in a gold rush, you’re better off selling picks and shovels to prospectors than actually prospecting for gold. In the current tech boom, there are countless lawyers, recruiters, real estate brokers, landlords and innumerable other professionals cashing in mightily, selling picks and shovels to us entrepreneurs.
Of course, the ability to raise rents, charge fees and book more work is predicated on the clients actually being able to pay – and like any smart player selling picks and shovels in a gold rush, they’ll get paid in cash please, not a percentage of the gold the prospectors might bring home.
While these folks don’t have as much of an active role in perpetuating the belief that more money raised is always better, they’re certainly very happy to help you spend it and post-justify the need to raise all that extra money in the first place – and their marketing spend can have a very direct effect on the economics of the third group, the media.
The tech press also plays an important part in perpetuating this perspective of the more money raised, the better. Aside from the newsworthiness of it – “Company X raises eye-popping amount of money” – the tech media are in a pretty tough spot when they cover private companies: they can’t report on revenue (it is private), growth (it is private), customer churn (yep, private) and a multitude of other things to create drama, comparisons or a commentary on who’s winning in the market.
The result is a comparison on the one thing that is commonly disclosed: the amount of funds raised. This means that this one metric is how many people who write articles (and more importantly, those who read them) are forced to reflect and compare.
There’s another subtle dimension as well, which surrounds how the tech press make their money: events. As revenue from advertising continues to come under pressure, the tech press are printing money with their conferences and events. These events draw sponsorship and millions in ticket sales, and result in more exclusive content from speakers and interviews. The sponsors and many of the 3000+ ticket holders are, of course, investors and service providers paying $3000 a seat for a 2-3 day conference. So, maintaining the focus on funds raised in the tech press helps keep the world going around.
I’m not claiming for a minute that there’s a conspiracy at play here – it’s just my attempt to understand why the view of “raise as much money as you can as often as you can” is such strong, prevailing advice. There are, as mentioned in the previous post, lots and lots of very good times where raising as much money as you can, whenever you can get it, is good advice – but this is my attempt at understanding why the advice is so universal when it really shouldn’t be. There’s just too many parties who influence the continual movement of the merry-go-round for it to be any other way.