The endless quest for investment is killing good startups
Tuesday, November 19, 2019/
Fundraising your startup takes valuable time away from the essentials, like building your products and improving customer experience. It has somehow become the norm in Startupland to run for money, instead of focusing on building great solutions and sustainable revenue.
Receiving investment is the new modus operandi for many early-stage startups and has almost become a new badge of honour. But the question: is it killing off good startups prematurely?
It seems counter-intuitive, but let me explain.
The investment system is broken
Some angels and venture capitalists now expect 10-30 times return on investment, and in return for their investment, they demand hyper-growth and introduce blitz-scaling; increase your size in a short amount of time and be the first to dominate your market. This is especially true for scale-ups.
These types of cash injections work much like doping — they make you faster.
For the already strong companies, it might set them up to win, but only a few will in the end. For the weak ones, it might kill them or leave them severely damaged.
Regardless of their condition at the time of investment, statistically speaking, they will fail. As we know around 90% of startups fail, and a Belgian study suggests VC-backed startups have an even higher probability of going bankrupt than those without VC backing. The study suggests VC-backed companies fail if the investment is cut because it is dragging down the portfolio for too long. We know all companies can hit a rough patch, but if they are VC-backed, their wings might get clipped prematurely, and they end up failing because they didn’t build sustainable revenue and instead focused on growing.
Does it matter if your startup fails? Not to the investors
Professional startup investors have a portfolio of startups they invest in. They spread their risk, and much like professional betting experts betting on horses, most of them can afford to lose some of their investments as long as one or two bets pay off big. Go big or go home is the mantra. But how many bets do you as a founder have? How many horses are your riding?
Investors are looking for deals with attractive cap tables, good terms and a clear exit strategy in a foreseeable timeframe. If there is a shortage of initial public offerings and merger and acquisitions in their portfolio, their liquidity and ability to make other investments will take a hit. Naturally, investors are then looking for deals in which they can eventually exit. This, in turn, then favours founders who are willing to play along in the hope of a big pay day. At least on paper. And while I, from an investment point-of-view, can sympathise with this approach, this is also the core of the issue I want to raise. Is betting big and running faster really leading to the kind of prosperity we are seeking?
Why are we building companies in the first place? Is it to solve problems for our customers in hopes of a big pay day, or is it to earn a living while solving them?
This one-size-fits-all VC model is not sustainable
Not only is it benefitting very few people in the end, it’s leaving a lot of people — founders and employees — in the dust.
Out-of-world investment sums and hyper growth has a destabilising effect in the market as it is propping up companies to unjustifiable valuations. We are racing to the bottom and we are pushing startups to their demise, many because they scale before they are ready. Startups that might have been able to thrive long-term.
Raising more money doesn’t necessarily mean a bigger payday, but it does mean less control
Incremental funding often means more dilution in ownership, so even if you are raising hundreds of millions in later rounds, it doesn’t mean a bigger cut for you when you exit. It just means more demands from other people — people who don’t necessarily know what it means to run your business or have the same intentions that you have. They will, however, wield their influence towards their goal of financial payoff.
A call for a new breed of investors
Let’s not kid ourselves: investing is mainly about gaining financial returns, and when they work out, there’s also a nice story about creating jobs. But what if it could be more than that? What if investors got involved long-term and cared about the people they are investing in? What if they loved the intricacies of building things? And what if we thought about catching people when they fall?
As this NY Times article suggests, more and more founders are tired of traditional VC firms and aren’t willing to take their money or advice anymore. There’s too great a focus on aggressive growth and exits from the investors, which then leads to misalignment of the trajectory of the startup. Too many investors are giving strategic advice in industries they have little to no operational experience in — essentially selling hot air.
We need VC investors who understand what it takes to run a startup. We need fewer investment-banker-types squeezing for favourable deals, and more founder-type-investors who understand that they are working with, and building solutions for, people.
Turn the system on its head
As a founder, you need to decide what kind of company you are building. Do you want to build incremental revenue and have organic growth, or are you aiming for all-or-nothing, with already staggering odds against you? The latter might be forced upon you if you go with investment.
Founders need to understand they are selling a slice of their dream when they get investment, and who they let into their circle can change the trajectory of their company.
We should turn the system on its head and revisit the idea that startups can do without capital injections. And when they do need them — there are times when they come in handy — we think long-term. We need to reiterate the norm of aiming for investment in aspiring to a dream of self-funding.
When you are playing to win in a market with heavily capitalised contenders, doping might be a great idea — or it might just kill you.
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