Yesterday we looked at the joys and perils of being in a startup heading in the right direction.  Today, some thoughts on funding.

photo courtesy of gnerk

Year 2: Raise as Little Money as Possible

Pros and cons of all-or-nothing moon shots

This is controversial.  Most ventures need some money before the revenue comes in.  But it comes at a price.

First example: We raised over $60M, on a valuation in excess of $200M.  We had great momentum, lots of customers and registered users, but virtually no revenue (in 2000, it was only us early adopters that actually had broadband and shopped online).  When you get funded like this, you’re on a boom-or-bust rocket ship.  Either you enter Geoffrey Moore’s tornado and emerge victorious, or you crash to earth in a ball of flames.  We blew most of it in one year on a big name CEO, hiring like crazy, and a new name (would you pay $1M to re-brand as Abilizer Solutions?) Guess what happened to us?

The downside of too much money can be reduced opportunities for focus and fewer exit options.  If your valuation becomes too high, you will turn down otherwise reasonable offers, and you may be driven out of your original niche market.  If perksatwork.com had raised $25M on a $75M valuation, an $85M offer would have worked for everyone after the crash.  Instead, when the dot com market imploded, we left the HR segment we dominated (because it was “unattractive”) and vanished into obscurity in the hotly contested portal software market with about 500 other dot coms.   (See Year 4  for more on this topic)

Edge Dynamics also suffered from too much funding.  We used our market momentum to raise more than we needed, forgot our frugal 10-guys-in-a-three-bedroom-condo beginnings, hired ahead of revenues, and found ourselves burning too much cash, with too complex a product to change easily when the market turned on us (more in Year 7).

In a small marketplace, the burn-up on re-entry of the previously dominant player can be a windfall for a smaller, nimble, and less heavily funded competitor.  I’ve seen this happen both in channel management for Edge Dynamics main competitor, and in the pedigree space following the demise of SupplyScape.

The new abundances of processing power, storage, and network capacity, and increased ability to outsource everything mean that many startups no longer need to raise significant venture money and take on the expectations that come with it.

The current challenges of raising significant capital have been a blessing in disguise for the most recent venture I’m advising. Over the last year, we’ve refined the plan stripping out complexity, outsourcing elements, and consequently increasing deal attractiveness while reducing funding requirements.

Key Takeaways: If you raise money, you might end up giving up a pint of blood.  Raise money from a position of strength (momentum). Unless you want an all-or-nothing moon shot, find a way to get by with less. And don’t spend it like you’ve already made it.

Sign Posts: How much money do you need to raise to be successful? How has spending changed since you’ve raised money?

Thoughts?