by Jonathan Krieger
The VC market is frothy. With Venture Capital investments up 22% in 2011 and average deal size on the rise, there is a lot of money floating around the startup world. In this “founders market” investors are eager to deploy capital, and when VC bank accounts start to resemble Scrooge McDuck’s vault, startup valuations and funding rounds rise.
While this presents great opportunities for entrepreneurs to fund their dreams, they should do so with caution. Frothy markets lead to overvaluations and, according to Mike Maples, “Too much money in a startup is not only unnecessary, it’s actually toxic.”*
It’s important for entrepreneurs to understand these toxins and be ready with anecdotes. This post focuses on 5 watchouts for over-funded entrepreneurs.
1) Pressure to meet overvaluation
High valuations come with pressure to pursue high-value business models. While this may sound trite (and maybe it is), it still deserves attention. In it’s early days a startup needs the flexibility to experiment and test different hypotheses and models. When you raise money at a high valuation, you may limit your ability to run certain types of tests. With high expectations, there’s pressure to only pursue the biggest opportunities. You may end up swinging for home runs and whiffing, when would have been better suited to hit a single or double.
2) Spend to long on bad ideas
Raising more cash than you need can make people lazy. You no longer have to guard every penny like it’s your last, which allows you to “pursue loosing strategies for too long to the detriment of winning strategy.”* (Mike Maples) When something isn’t working you may keep throwing cash at it to see if you can make it work. This not only wastes money, but also valuable human resources that should be directed to new ideas.
3) Scale before achieving product-market fit
According to Marc Andreessen, “Product/market fit means being in a good market with a product that can satisfy that market.”** This is no easy task and requires time and testing. Once you find product/market fit, you can build out your organization and scale it – but not before.
When companies raise too much money too fast they may feel pressure to quickly show results, and scale before achieving product/market fit. This leads to unnecessary spending - hiring people and acquiring assets that may not match your business. Don’t let over-funding distract you from this key piece of entrepreneurship. As Jeff Bussgang says you need to “nail it before you scale it!”***
4) Cushion to stay in your comfort zone
Cash provides comfort. It’s a soft fluffy cushion that allows entrepreneurs to stick to business activities that are comfortable, and put off activities that are critical. Tech teams like to build and may need the pressure of a dwindling bank account to get out and sell.****
5) Hire expensive talent you don’t need
Another danger of cash-flushed coffers is the urge to hire talent you aren’t ready for. A big bank account lets you hire “big-company execs who look great on paper but may not do particularly well in a startup setting.”**** Just because you can hire someone doesn’t mean you should. It’s better to let investors’ money rest than put it to work on the wrong things.
These are just a few of the risks that come with over-funding. What other watchouts can you think of and what can entrepreneurs do to avoid them? Comments welcome.
* Mike Maples Jr. Entrepreneurial Thought Leaders Lecture, Stanford University, January 2008.
** Marc Andreessen “The Pmarca Guide to Startups, part 4: The only thing that matters,” Oct 2009.
*** Juff Bussgang “Presentation on Product-Market-Fit,” slide 6, March 2011.
**** Jim Andelman “What mistakes do over-funded and under-funded startups usually make?” Sept 2011.
