July 30, 2015
Starting a company is like attempting to bend the world to your will. There are obstacles at every turn, and it’s never easy. Fundraising is one of those huge obstructions. Not only is the process of finding the true believers akin to finding the proverbial needle in the haystack, it’s also incredibly distracting.
Raising more money to reach a technical milestone or to fuel a successful customer acquisition strategy are worth the distraction and pain. Raising a big round because your competitor just did, essentially keeping up with the Startup Joneses, is an all-too-common waste of time that can cripple your company.
I’ve often seen this happen to founders of companies with seemingly “successful” competition. Success in this case is often defined by capital raised, rather than satisfied customers. Founders become obsessed with the volume and valuation of a competitor’s latest round of funding. In some cases, this isn’t even direct competition, but tangential competition that has no bearing at all on the founder’s startup.
Fundraising is not a legitimate forum for competition.
Visions of an even larger round, using their competitors fundraise as justification, begin to take shape. After all, if a rival company can raise $15 million with trivial traction, why can’t we? VCs intrigued by a hot category, and plagued by FOMO, will at least take a meeting — sometimes even several meetings. Multiply that by the many VCs willing to take a meeting, and the founders are focused on an unnecessary fundraising process rather than figuring out how to build a great business.
In most cases, this is a really bad idea. These competitors are noise. Their financings are extremely distracting noise. Ignore it, or you’ll find yourself wasting time with the Joneses instead of building your startup.
Raise Money On Your Toes, Not Your Heels
Money should be raised with clear sight lines to how it will move the needle for your customers and your business, not as a reaction to competitors. Fundraising is not a legitimate forum for competition. Raising more money than competitors can give founders the false sense that they are winning. They aren’t. As a result, founders lose sight of legitimate validation of winning the market.
How does a founder reconcile that a less impressive competitor has raised so much capital? Venture capital can be capricious. Investors have eclectic tastes. A particular VC may have strong relationships with a particular entrepreneur or be privy to some market knowledge that you aren’t.
In any case, it’s a bad idea to assume that just because a competitor raised a huge round that it will be easy for you. It’s possible that if the VC had a bad day on the first meeting with your competitor, the deal might never have consummated. Don’t let yourself be at the whim of investors.
Don’t depend on venture capitalists, or anyone other than your customers, for validation. Prove your product’s value with traction. Remember, VCs are financiers, not oracles.
A Natural Experiment
An example of this phenomena can be found by comparing the histories of Digg and Reddit. Both companies were started at roughly the same time and offered basically similar functionality. Reddit raised $100,000 and was quickly acquired by Conde Nast for between $10 million and $20 million. Digg raised $45 million over four rounds of financing. Many predicted Reddit would be smashed by their better-funded competitor.
However, Digg struggled to reconcile its user needs with the need to generate revenue, and ultimately collapsed under the weight of their investor’s expectations. Reddit focused on building a community, was spun-out as a startup, and is now the 11th largest site on the web with a fresh $50 million in funding. This cartoon tells the story in so many words.
Could Reddit have been as successful if they spent most of their cycles keeping up with Digg’s balance sheet? It would have been easy for Reddit to raise funding to fight Digg, but they played the long game, focused on their users and, ultimately, made the bigger impact.
Capital Is Rarely The Real Constraint
Money will solve surprisingly few of your problems. Money is not what’s keeping you from finding a unique way to reach your customers. You can pilot most channels with a few thousand dollars, and when your fundamentals work, money becomes very easy to raise.
Mailchimp and Atlassian bootstrapped their way to nine-figure revenues in the B2B market. Wayfair, a consumer-facing e-commerce company in Boston, deftly used payment terms to build a billion-dollar retail brand without funding, and first raised capital when they had more than $500 million in revenue. Money matters, but not as much as a maniacal focus on your business.
Only raise money if you know how it will make your company smarter or more valuable.
Funding should almost never be used to “catch up” to a competitor. Vying for parity in product, advertising and staffing is a distraction. Fatal blows usually come from missing key insights about your users, not features.
Network-effects businesses, with winner-takes-all dynamics, would seem to be an exception to this rule. However, Facebook is the clear winner in social networking, despite that MySpace had no shortage of capital supporting its implosion.
Instagram, Snapchat, Twitter, Tumblr, Pinterest, WhatsApp, WeChat and others managed to carve out multi-billion dollar niches, not by copying Facebook or by being equally capitalized, but by amplifying key aspects of it.
If you make customers happy, develop a business model that jibes with your product and have patience, there is very little that can keep you from success.
Instead of trying to catch up to a competitor, think about how you can use capital to uniquely serve a subset of the market. Don’t use money to close a gap in a race, use it to change the game. If capital was the key ingredient to success, no startup would stand a chance against well-funded incumbents. Yet startups successfully take on incumbents every day with a sliver of the capital.
The Tyranny Of Incrementalism
Money can actually slow down startups, a problem I’ve referred to as “Tyranny of Incrementalism.”
This is what happens when a company closes capital and long-awaited VPs are hired, who in turn hire directors and analysts, and have requests for budget. Progress against the product roadmap slows as more people need to be brought up to speed. Previously successful marketing strategies begin to stall at scale. The larger the ship, the harder it is to turn.
Often the speed you hoped to achieve is retarded by the growing pains. These slowdowns are compounded when the executive team doesn’t have a clear view of how to apply the dollars. Gas in the tank fuels the engine — bathing your car in gas is a disaster waiting to happen.
Hyperdrive, Not Joy Ride
Frothy funding environments reinforce bad habits. Venture capital is a tool designed for a very specific purpose. It’s hyperdrive. If you lay in the proper course, it will take you far. If you haven’t, you’ll just be way off the mark and beyond the reach of anyone to save you.
Almost every CEO of a failed startup will blame a lack of cash for their company’s demise. And there is no doubt that many a startup has been subject to the whims of the capital markets, but the reality is, if you make customers happy, develop a business model that jibes with your product and have patience, there is very little that can keep you from success — no matter how much more money the Joneses raise.