There has been a lot of money sloshing around the startup world for the past few years. Cheap and accessible capital has advantages: More founders get the opportunity to pursue big dreams and previously “unfundable companies” not only raise huge amounts of money, but some ultimately achieve unicorn status.

Discussions about the downside of this trend are usually related to systemic risks, like the perpetual bubble talk, but few are discussing the problem as it relates to founders — more capital equals more risk. But who is bearing this risk, and what really is the downside? Sure, capital providers are taking this risk — but they aren’t the only ones.

Venture capital increases risk for founders

On a short-term basis, raising VC reduces a founder’s personal risk by allowing the team to draw a salary. Founders don’t need to put development costs on a credit card or face short-term economic hardship. But while counter-intuitive, raising venture capital makes your startup riskier in two key ways.

You limit your exits 

VC cash comes at the cost of reduced exit flexibility and the burden of an increased burn rate. Viewed probabilistically, the most likely positive exit for a startup is an acquisition for less than $50 million. This outcome has little benefit to VCs, and they will happily trade it for an improbable shot at a higher outcome.

Think of venture capital as a power tool — in the right hands, power tools can solve some real problems.

I regularly see entrepreneurs agonize over a percent of dilution, while ignoring the fact that they are surrendering their most likely exit options for a low-probability shot at building a superstar startup. Billions of dollars have been outright wasted by founders selling future value that didn’t materialize, while surrendering present value that could have been navigated to great success. My advice: Don’t give up your present for a future you haven’t validated.

You increase burn to dangerous levels 

Beyond signing away exit options, new venture capital typically is raised to fund higher burn rates. That increased burn rate is a great investment when it is being used to fuel a model that is working. More often, the increased burn is used to search for a model that works, and the company quickly learns that capital has no insights; it’s just money. Then the company cannot sustain the burn, the CEO decides to cut the burn way too late and cannot manufacture enough VC enthusiasm to keep the dream alive.

Every dollar you spend is a dollar of dilution. One rough rule of thumb is that startups should be able to triple their post-money valuation in two years. If you can’t figure out how to get 3X leverage on every dollar you spend, you’re better off not spending the dollars — or raising them in the first place.

Founders need to think of venture capital as a power tool — a fairly dangerous one — but instead often mistake it for some magical, infinitely renewable resource. In the right hands, power tools can solve some real problems. Used incorrectly, they can chop off your hands.

VCs need billion-dollar exits — you don’t

Billion-dollar exits are brilliant, but they shouldn’t be how founders calibrate success. The mania for billion-dollar valuations is the result of the business model of the venture capital market — not some legitimate definition of startup success.

Here’s a very rough illustration of billion-dollar VC fund logic:

  • VC raises a billion-dollar fund, needs to triple the fund to be successful
  • VC makes ~30 major investments
  • VC breaks even on 10, loses money on 10, needs remaining 10 to be worth an average of ~$300 million in proceeds to their fund
  • VC can only expect to own 20-30 percent of any given company (often less); anything less than $1 billion exit of your business isn’t a success in this model

This is why there is so much focus on billion-dollar exits. Not because this outcome is high frequency, but because a few massive funds need it to be so. Let’s not just point fingers at the billion-dollar funds. Similar VC math causes irrational trade-offs for founders whether their investors have billion-dollar funds or quarter-billion-dollar funds.

Capital has no insights; it’s just money.

As a general rule of thumb, assume that your exit needs to be approximately the size of the VC fund to “matter” in its returns. Of course, this is the tail wagging the dog, as the capital gatherers are encouraging irrational behavior of founders with a sales pitch of “go big or go home.” No one says the truth, which is “go big or ruin your life.”

When your business fails, which probability says it most likely will, that VC has 29 more shots on goal. You destroyed your single startup, not to mention the wasted sacrifice over years of your life. In most VC deals, the investor is taking much less risk than the founder.

This is just fine for a subset of founders. It’s great that Ferraris exist, but it doesn’t make sense for the average person to mortgage their home and their future to buy one when a Toyota Prius can fetch groceries just fine.

Exit value is a vanity metric

If one of your goals is making money, focusing on the exit price is a bad idea. It’s quite possible to sell a startup for a billion dollars and make less than someone who sells theirs for $100 million.

For example, the Huffington Post was reportedly acquired for $314 million, and Arianna Huffington made about $18 million. Michael Arrington sold TechCrunch to the same buyer for $30 million and reportedly kept $24 million. To a VC, TechCrunch’s sale would have been a “loss,” and many VCs would have pushed Michael not to sell. Yet Arrington was more successful, financially, than Huffington.

Practice efficient entrepreneurship

One argument I’ve heard from many VCs is that a founder won’t build a billion-dollar startup unless they go all-in from the start. This is nonsense — to become a billion-dollar business, a founder first needs to build a $10 million business. Founders shouldn’t jump to the end game before they’re ready. You focus on the first step and still become a huge player in the end.

Don’t give up your present for a future you haven’t validated.

This is empirically true — just look at WayfairBraintreeShutterstockSurveyMonkeyPlenty of FishShopifyLyndaGitHubAtlassianMailChimpEpicCampaign MonitorMinecraftLootCrateUnityCarGurus and SimpliSafe to name just a few. None of these startups embraced the “billions or bust” mentality at the start, though many are worth billions now. Most took very little venture capital until after they proved out product/market fit and knew how they could use the money to accelerate growth. Some didn’t take any capital at all.

All were hyper-efficient in the way they used capital from Day One. Several have gone public, a few have been acquired for billion-dollar sums. I don’t fetishize bootstrapping, but there is a lot to learn by studying how these founders built huge businesses with efficient use of capital.

Smart people, dumb money 

I was very happy to build and sell a startup for nearly $100 million, and while I would have liked to build a billion-dollar business, too many founders treat the probability of either outcome as close to equal. Earning billion-dollar exits is startup nirvana, for sure. But selling for $500 million is a home run, $100 million exits are amazing and $50 million exits can change the lives of families for generations. Even a “humble” million-dollar exit can make a huge difference in a founder’s life.

The point is, don’t be so quick to irrationally trade all of those options! Only trade these options when you’ve proven enough to have confidence that the future value of your company will be much higher. Capital has no insights. Don’t trade a solid business for a lottery ticket.

Irrationally raising money to scale something that doesn’t work does not result in building a big business. Founders should focus on smart growth and use VC to support that — instead of treating it like a steroid. Make efficient entrepreneurship your mantra. By all means, dream big — I’m not arguing that founders build small companies, solving small problems. If you have a legitimate need for capital, by all means raise it. But on the flip side, don’t sell your chance for success by giving up optionality and prematurely scaling burn rate in the name of fundraising glory.

Venture capital isn’t the right choice for most businesses, but when used well, it can be very powerful. Unfortunately, many VC-backed founders are using it incorrectly.

In 1961, President John F. Kennedy told a joint session of Congress that before the end of the decade, America would put a man on the moon. This was not an empty political promise to get elected, but a commitment of a sitting president boldly exposing himself to political ridicule in the face of failure.

If we can take ourselves back to that moment, it would be fascinating to analyze the probability that such a feat could be accomplished. It had never even been close to being achieved and was perceived by many to be insanely risky. It was only six weeks after the first human cosmonaut Yuri Gagarin had visited space in a short suborbital flight and three weeks after American Alan Shepard had repeated this historic milestone.

Needless to say, the odds were long and our president was far from proposing something with a highly probable outcome. Had his ambitions defied the laws of physics, our best engineering plans indicated we were decades away, or cost estimates required more capital than US GDP, perhaps it would have been delusional. Instead, history would prove that Kennedy was imaging an improbable, yet possible future.

The probable

In my short two-year stint working in corporate America, I have learned a great deal about probable outcomes. Senior executives didn’t dare propose things that were merely possible. Proposals required evidence of a high probability of success. One could derail a carefully crafted career over missing a forecast by 20 percent, let alone being a year late on launch of a product. It was unwise to take real risks and dream big in such an environment.

When planning for a new product launch, numbers and timelines were always very conservative, as it was considered irresponsible to imagine the possible but improbable upside. We were taught to keep things grounded in highly probable outcomes and, not surprisingly, rarely created any outcomes beyond conservative ones, as we were never inspired or incentivized to do so. Not surprising so few large company executives function well in the startup world.

The delusional entrepreneur will procrastinate finding that invalidating data for as long as possible, and then still be dismissive of the results.

The possible

By contrast, in startups, great outcomes are never probable. The expected return of nearly every startup at the beginning is frighteningly close to zero. In the context of my corporate experience, it seems astonishing that anyone would ever start a company. Perhaps that’s why so few corporate executives ever chose to do so. Startups only exist because their founders are willing to suspend the disbelief of the probable and instead consider what is possible.

I’ve joked that no early-stage startup should ever beat its plan; beating a plan would suggest that the founder didn’t imagine the totality of what was possible and undersold the potential of the startup.

Dreaming big is the reason so many startups will fall short of their plan and nonetheless deserve to be called successful. Falling short of the extreme of the possible can yield a very exciting business. Corporate America might fire you, but an acquirer, by contrast, might reward you with a very significant exit.

The delusional

At the other extreme from the probable approach is a very dangerous view of the world – the delusional. Some startup founders are so enthusiastic that they dream of futures that are not credible; they dismiss the need for customer feedback to validate their view; and they have no indicators that suggest they can build what they imagine.

Many things can be quickly tested, and when data invalidates a hypothesis, it is very much time to move on. The delusional entrepreneur will procrastinate finding that invalidating data for as long as possible, and then still be dismissive of the results. These founders will burn through all the money and talent he can garner, but with little or no value creation at the end.

With the probable, there would be no reason to start a company. With the delusional, there is a real risk that the founder is wasting years of his life on something that will never materialize outside of his own head. There is no truth of pre-ordained outcome when starting a company. Great founders live between these extremes in the world of the possible and inspire others to share that worldview.

They test those possibilities every day and frequently refine what they believe is possible to find a winning path. Living in the world of the possible is how we put a human on the moon and how we will imagine and create the valuable technologies and companies of tomorrow. Keep your eyes to the sky and your feet planted firmly on the ground.

Many business critics of Uber contend that the company is spending “unsustainably.” Despite that nearly all venture-backed startups burn capital unsustainably, Uber’s level of spending is viewed as particularly problematic among its naysayers. Negative press notwithstanding, Uber has now raised billions of dollars — many times over. How is this possible?

Uber’s investors, myself included, are still wildly enthusiastic about the unprecedented velocity of the company. It will be able to sustain its burn rate based on that excitement unless something surprising happens to its business, or it goes public.

It doesn’t matter whether a company’s burn rate is $10K per month or $10 million per month, companies die when their burn rates are greater than investor enthusiasm. Burn rate is a bet on the potential of a business. That bet, re-evaluated at each round of funding, is based on the belief of venture capitalists that multiples of value will be created with the money they invest in a company. Unfortunately for founders, enthusiasm can be fickle while burn rates are stubborn. The two can easily get out of sync.

Quirky is an example of what happens when a startup loses investor enthusiasm. The innovative home goods manufacturer raised huge amounts of capital, struck partnerships with GE and major retailers, and promised to disrupt the way household goods are made. Investors bought into this vision and the company hired a large team of engineers and designers, built world-class facilities and retail shops, and spent heavily on marketing.

Then products were delayed. Critics ridiculed their offerings. Their slick inventions stuck to store shelves. Expensive gambles failed to pay off. Quirky wasn’t worthless, but it no longer could justify its burn rate or sustain investor enthusiasm and ultimately died with the remains to be sold off as scraps.

The enthusiasm cycle

Founders exude enthusiasm. This enthusiasm is the currency for any startup. Co-founders join when they have drunk the Kool-Aid of the first founder. Then additional team members. Then investors. Investor pitches are inspiring and grandiose. Pitches are designed to garner enthusiasm.

Venture capital financing rounds suggest an implicit burn rate, typically intended to be invested in the startup over 12-24 months. Some basic math would suggest that for an imaginary $1.8 million financing to be burned down over 18 months, the company is spending $100K a month on average. Of course there is a curve to this burn rate that starts lower, as the company is scaling up, and finishes the period higher — more like $200K per month — which becomes the new baseline. It is this exit burn rate that needs to be sustained with new capital.

As a startup exits each financing period and needs more capital, it hits an important inflection point. Investor enthusiasm internal or external to the company hasn’t been tested in 18 months. The exit burn from the financing stage doesn’t necessarily reflect current enthusiasm. Instead it reflects the autopilot burn rate based assumptions 18 months earlier. Now the company needs to raise more money to fund at least a $200K per month burn rate (and hopefully additional growth). The key question is how enthusiastic is everyone now?

If the money invested is showing great signs of return, then enthusiasm will likely be high and the company will attract more capital with little difficulty. Unfortunately, this frequently isn’t the case. More often, money has been spent, the company has made some progress, and the results are mixed.

Given that there is a deepening curve to burn rate over the post financing period, sustaining the burn rate nearly always requires more capital than went in at the previous financing round. But because the burn rate increased to $200K/month, buying another 18 months now costs $3.6 million. Are the investors twice as enthusiastic about the company as when they wrote the last $1.8 million check? If not, the company is in trouble.

Never think of burn rate as a prescribed plan at the time of investment to be set on autopilot, and don’t assume that investors will keep funding the burn when the bank account approaches empty.

Why investors lose enthusiasm

The dream dies. Investors write checks into big dreams, which are validated by traction. If the trend line of the previous 18 months isn’t accelerating up and to the right, the excitement that generated the original investment is lost and the dream becomes a nightmare.

Founder flailing. Few startup founders are truly exceptional, and it’s hard to build an amazing startup. I’ve met many investors who are thrilled about the concept of a company, work hard with the team to make it a reality, but become frustrated by the inability of the founders to execute. Sometimes an investor will look to replace the founders in this context. Other times they’ll throw up their hands and lose interest in the startup.

Macro changes. The macro environment plays a significant role in whether investors are open-minded or close-minded to a vision of the future. The more traction a company has, the less impact the macro environment has on investor enthusiasm, but even startups with solid metrics struggle to raise money during major macro shifts, like the 2008 financial crisis. Moreover, startups that are doing well, often face down rounds in a souring economic climate.

It may be that the company had an easier time raising the previous round because the investor confidence in the macro environment made it possible for investors to dream along with the founders, and by the time the company is out for more capital, that environment has shifted. It is hard to dream big dreams when the prevailing economic sentiment is fear.

During the 2008 financial crisis, companies that were funded 12-18 months before and had solid metrics struggled to inspire enthusiasm from fearful investors. Sometimes the shift is less dramatic, and a single sector will fall out of favor. I think many early-stage e-commerce companies are feeling this squeeze right now, where investor enthusiasm for e-commerce was much stronger a couple years ago.

What to do if enthusiasm wanes

Should the startup search for external money without strong internal support? This rarely works out. Outside investors are always trying to read the tea leaves to understand how insiders feel, as they have way more insight into the company and leadership.

So how can a company manage the enthusiasm challenge? Keep a very close eye on the disconnect between burn rate and enthusiasm. Never think of burn rate as a prescribed plan at the time of investment to be set on autopilot, and don’t assume that investors will keep funding the burn when the bank account approaches empty. It’s the founder’s job to drive enthusiasm for more financial support by building traction in the business and not burning ahead of that enthusiasm.

Remember that the burn rate represents the plan from a moment of high enthusiasm and that the enthusiasm may or may not sustain. The key question is whether the investors would still write their check, if given the choice, as time passes and the burn increases. Are they as excited today as when they wrote the last check? If not, don’t hit the gas; perhaps even back off the burn. Find some metric and make it grow fast. Nothing sparks enthusiasm like momentum. Seek out kindred investors who are willing to back your audacious vision through a tough macro turn.

Don’t let your most enthusiastic supporters burn out. That’s how startups die.

The Platform Paradox

November 28, 2015

I often hear VCs say that they don’t back products, they back platforms. I find that logic backwards and in many ways dangerous for founders. Platforms can provide a durable competitive advantage, and it’s easy to understand why startups would want to create one. But great platforms are nearly always born from companies first creating great products with narrow, but compelling use cases.

Founders have a hard time accepting this advice, because they hear that VCs only want to back businesses with unicorn potential. They have difficulty imagining that a niche point solution could fit the bill. So they dream up a story of how their startup could become a platform and lose focus on the problem they’re solving.

The Difference Between A Platform And A Product

Given all the discussion of platforms, networks, marketplaces and horizontal strategies, it’s surprising that more hasn’t been written defining and delineating these terms. Before I explain why entrepreneurs should ignore the platform logic, I will do my best to provide definitions to these different concepts. I do not consider these definitions to be comprehensive and am open to engaging with anyone who thinks about these concepts differently.


Products are tools or services that you have some exclusive ownership of or access to. iPhones and GoPros are products. Microsoft Office and Adobe Photoshop are products. Candy Crush and The New York Times mobile app are products.

You might pay a flat price, a SaaS fee, trade your attention for ads, get some amount of free usage or partake in in-app purchases, but the concept is the same. You buy or sign up for something and use it. A good product solves a specific need for the user whether a trivial utility or a practical one.


Amazon Web Services, iOS and Android are platforms. The distinguishing aspect of a platform is the ability for others to build products and ultimately generate revenue on top of it, often in ways the platform creator never imagined. Platforms generate revenue by taking a cut of proceeds, and costs tend to scale in proportion to their use.


People often confuse “platforms” with products that posses network effects, but they are different things. LinkedIn is a network, that later became a platform for recruiting. Pinterest is a beautiful interest graph and not a development platform, yet it is becoming a platform for advertising as it grows. Both services offer APIs, but an API does not a platform make.

Marketplaces like eBay, Airbnb and Etsy are networked products that feel like platforms because you can make money using them, but limit the ways you can use them. I can’t sell a car on Airbnb or rent a castle on eBay. The primary value in marketplaces is derived from the liquidity. You’re not building value on top of these networks, you’re exchanging value within them.

There is value to be created on the margins of these services — listing management tools for eBay power sellers, or home cleaners for Airbnb hosts — but the primary value creation accrues to the company who creates the network. Airbnb is no more a platform for housekeepers than a high rise office building is.

Reasonable people can disagree with these definitions. For instance, each of these companies is a “product” company of one sort or another. But they at least clarify some major distinctions.

Humor VCs When They Bring Up Platforms

Most VCs have never built companies and some do not fully appreciate the challenges of doing so. Founders may have a great idea for a startup that would solve a real problem. There may even be a clear revenue model, but the founders fear that it all sounds too small. Instead of touting their product, founders dream up some abstract notion that combines a multibillion-dollar Total Addressable Market (TAM) that applies tech in some incredibly bold, yet ambiguous way.

VCs start by looking at the billion-dollar platform idea and want to believe that you’ll birth your company to achieve the end state on day one. There is nothing wrong with painting the big picture of what your company will become over time, but make sure those VCs know that you’re going to start by solving a real problem for customers and that you’re going to build a product now that hopefully can become a platform over time. Most importantly, tell them you’re not going to get distracted building a grandiose platform that no one wants today.

This is how platform logic becomes dangerous. When specs are broad enough to apply to many different customers, they often work well for no one. Product managers dabble with small customizations, but try to preserve the breadth to do anything. Horizontal platforms leave startups waiting for markets to come to them. That can take a long time. It usually never happens.

Narrow, vertical product use cases often seem insignificant compared to the promise of a platform. Unfortunately, products and platforms are mutually exclusive at early-stage startups. It is nearly impossible to offer a high-quality use case while also being a platform.

When I hear founders who barely have a demo talk about their “platform play,” I hear a founder without a clear grasp of their customers’ needs. Abstraction lends itself to grand pronouncements, but is usually so general as to be unactionable.

At that point I ask about how the platform will reach critical mass. What follows is invariably hand-waving of some sort. The marketing plan usually involves a few key influencers and a hodge-podge of unquantifiable marketing programs, but it is nearly impossible to build critical mass when no one understands what specific problem you’re solving.

Having a big vision is usually a good thing unless it becomes a huge distraction. To become a platform you first need to build a product that speaks to a compelling use case.

Build a Single Player Mode

If you’re stuck on the notion of building a platform, at least devote time to developing a credible “Single Player Mode.” Whatever you build should offer value even if only one person signs up. Instagram helps people take better photos, and the network comes afterward. Pinterest can serve as a mood board for crafters; the connections it enables turn it into a sewing circle with global scale. Minecraft is like the world’s biggest LEGO set, and an Internet connection turns it into the world’s biggest playgroup.

Don’t Trust Me—Study Bezos, Zuckerberg, and Jobs

Platforms can be compelling businesses, but it’s nearly impossible for a startup to create one from scratch. Remember when Google tried to build a Glass Collective (imitation is the greatest form of flattery) with support from A16Z and Kleiner Perkins, but still ended up killing the project? Ultimately Google should have prioritized building a compelling product rather than building a platform for a product nobody wanted.

The reality is that most platforms in the startup world emerge as the byproduct of a successful product solution. Amazon’s AWS, Facebook and iOS are arguably three of the most important platforms in tech today, but each company entered the platform business somewhat unwittingly.


Amazon Web Services (AWS) has become a core part of the startup infrastructure and has probably been the single-most important innovation responsible for the explosion of startups since the formalization of the HTTP standard.

But remember, Amazon didn’t set out to build a generic computing infrastructure platform, they sold Harlequin romance novels, DVD box sets of Lost, tennis rackets and millions of other products.

It wasn’t until they mastered the grubby art of shipping and receiving that they turned their attention towards computing services. Their platform was the byproduct of a much loved and trusted point solution, not the company’s focus.

Even when they did make the move into building a platform, it was marketed directly to a specific customer — startup founders. Privacy regulations in healthcare and finance and security concerns in the enterprise, made it a poor fit to start, so they ignored those markets. They didn’t make gauzy promises to a wide swath of companies, they built a use case that was exactly what high-growth startups needed.

Amazon was founded in 1994, didn’t offer AWS until 2006, and only started breaking out earnings for AWS in 2015. There’s no reason your business couldn’t become a platform in time, but keep in mind that it took one of the most successful web companies in history over a decade to get there. Pace yourself.



This was not a platform.

Building a platform wasn’t Mark Zuckerberg’s original goal. He didn’t even have photo sharing in V.1 of

Before it became the platform that popularized Farmville, it was a simple product that let college students search their friends’ friends. Now it powers login across the web and is the fastest growing ad platform in history.

Facebook was founded in 2004. It wasn’t until 2007, and a user base with hundreds of millions of users, that it announced its first efforts at becoming platform. That’s three years of building an amazing product, listening to their user base, and focusing on Facebook the product and network. Remember, the platform that has connected a billion and a half people couldn’t be accessed without an .edu email address a decade ago.



Apple didn’t even have enough apps to fill out the home screen, never mind an app store, at launch.

It’s hard to remember, but when the iPhone launched in 2007 it was “just” the best smartphone the world had ever seen. It didn’t even have copy and paste, and the “There’s an App for That” ad campaigns and billion dollar payouts to developers were still a couple years away.

Software engineers were knocking down Apple’s door to build apps, basically offering Apple a platform from day one, and the company rebuffed them, encouraging developers to build web apps instead.

Think about that. Apple was riding a hot streak of success with the iPod, had billions of dollars in the bank, and legions of fanatics and friendly voices in the press. The company had the opportunity to build a platform from day one and paused, realizing that it needed to focus on the product’s core use before opening it up to a wider audience. Today, iOS is one of the most important platforms in the history of computing, but it started simply as a slick product.

Unless you’re smarter than Steve Jobs, start by solving a problem for your customer and only become a platform when you’ve become the standard in solving that problem.

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.

Catching Up

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.

Nearly all startups use the same methodology to figure out when to raise their next round of capital. The founder projects the planned burn rate and estimates the day they will run out of cash. Then they subtract a margin for fundraising approximately four months from the date the company’s bank account will be empty, and declare the difference the fundraising-process start date.

While logical, this method is highly flawed. It’s predicated on the idea that running out ofmoney is the key milestone upon which to base a fundraising. However, running out of money isn’t a milestone — it’s exactly the opposite.

Milestones should be accretive to the value of your business; they typically come from key proof points that validate important hypotheses. Milestones can be based on the product or technology (a great prototype); customer validation (a key contract); legal (overcoming a regulatory hurdle); or financial (meaningful revenue growth).

Running out of cash is the opposite of a milestone — it’s the ultimate moment of vulnerability. Running out of money is Game Over. Some investors will try to take advantage of that moment of vulnerability with very tough terms, but that worries me less than the true implication of being vulnerable. Vulnerable companies are simply unappealing to investors, and often cannot attract capital on any terms.

<h2>Let your bold vision and capable execution, not your bank account, determine what your company will become.</h2>

Investors are motivated to write checks when they feel like your company presents a great opportunity to return multiples on capital. Investors believe in the opportunity because of the narrative of the company and the evidence that the company amasses validating that narrative. Companies rarely look less likely to return to investors than when they are about to run out of money.

The cash crisis undermines the narrative. Even if other milestones in the business are positive and appear equal, it is much easier to attract capital as a company with eight months of cash than the same company with two months of remaining cash. As the company runs low on cash, it starts to smell funny to investors, who start to ask themselves questions like how did the company get into this situation? And if this is such a great opportunity, why didn’t anyone else want to write a check?

So what’s an early stage founder to do about the cash vulnerability predicament? First, I’d suggest leaving more room for error. Ideally, don’t raise 12 months of capital out of the gate, expecting to go back out raising in eight months when down to four months of cash. Instead, raise 18 months of capital and start raising again when down to nine months of capital in the bank.

When debating this with founders, I often hear two arguments for waiting until almost outof capital to raise the next round. First is that the company’s progress is so significant month after month that its valuation will be meaningfully better by waiting as late as possible to raise. We’ve been lucky enough to experience this situation several times when revenue doubled by waiting three more months and the growth resulted in a much more successful fundraising.

This is a fair reason to wait, but the founder must be very confident that the evidence will make a fundraise easy. Resist the temptation to believe that by burning cash to the brink, the company will have so much progress the valuation will appreciate despite the burden of the impending lack of cash. It rarely works out that way.

The other explanation I hear is that the milestones of the company aren’t particularly strong and the founder needs as much time as possible to prove as much as they can. In other words, had the company tried to raise with 6-9 months of capital still on the books, it would have little to show to prospective investors.

Further, they argue that even with 4-6 months of cash remaining, the company won’t have compelling milestones to share with investors. The company needs to show the progress that comes from burning until almost out of cash to have the best chance of convincing new investors to write a check.

This is usually faulty logic. Companies in this situation rarely successfully pull off the Hail Mary pass with seconds left on the clock. Instead, they face diminishing returns, while further damaging the outlook of the company by being on the edge of running out of cash.

No one wants to write checks for this type of company. If the founder had been out looking for an extension with 6-9 months of cash, it could have still raised capital with the halo of promise. In this stage, the company looks more dead than alive, and the halo has faded.

In this situation, I suggest founders consider early seed extensions. If the company is progressing extremely well, this is completely unnecessary and the company should start raising Series A early. However, without major leaps forward, it is much easier to top up a seed round when a company still has 6-9 months of capital than with modestly more business progress but 60 days of cash left and waning inside commitment.

Some people in the startup world believe that good companies succeed and bad companies fail. While rare companies find incredible success right out of the gate, I don’t agree with this view. Some companies become good companies over time because they find ways to finance their way through lots of challenges. Other companies, with great promise, become bad companies because they don’t plan their financing well and they lose the opportunity to live up to their potential.

Let your bold vision and capable execution, not your bank account, determine what your company will become.

When seed capital hits the books, the outlook of every startup is one of unbridled optimism. Founders, team members and investors are inspired by a singular vision and believe it can materialize into a world-changing company.

If things go right and the product gets amazing results, optimism turns into euphoria. There are few experiences more rewarding than making big collective bets and winning together. This is the ideal of every startup that we all aspire to be out of the gate.

However, somewhere between raising money on the promise of a great vision and a unicorn valuation, almost every startup endures a challenging purgatory that requires patience. The longer this “patient stage,” the greater the natural strain on the key relationships in the startup become, eroding away the ideal that everyone hoped for at the start.

This strain comes with significant risks. Both for investors and founders, but also between co-founders and management team members that might have different solutions for how to emerge from the patient stage. How you manage this stage is often the difference between your company thriving or dying.

Recognizing You’re Stuck in the “Patient Stage”

The patient stage typically looks something like this: Your startup raises money and, after a bunch of product delays, finally gets something into the market. Everyone expects a hit and the results are somewhere between okay and disappointing.

Not to worry; the team thinks it knows what needs to be fixed. After all, this was the minimal viable product and the entire point was to learn. Albeit delayed, everyone learned a ton from the MVP, and the company needs time to make some fixes.

After more delays, a new version ships. The results are better, but still far from the aspirations of everyone involved. The process repeats, possibly shedding some team members along the way. You pass the messiah T-shirt to various new hires who suspect they know how to fix the problem, but ultimately are only another piece in a very complicated puzzle.

While this example focuses on product, the same spiral of purgatory can apply if your company is stuck trying to find the right sales approach, marketing channels, operating plan, business model or supply chain. Whatever the company’s struggles, if the progress isn’t incredibly clear, more and more patience is required to support you and the company.

Escaping the Patient Stage

Unfortunately, this is the typical path that must be overcome by even successful startups. The question for founders and their boards is how to get through the inevitable patient stage together.

Your leadership credibility is the key to success through this stage. If investors or team members lose trust in your leadership through challenging results and frequent iterations, the company can find itself in a very precarious position.

The biggest mistakes you can make in the patient stage are either denying the problem exists or pretending that ill-conceived solutions will fix everything.

Your investors are there to help and want to be supportive, but as your credibility declines with every disagreement about the problem or the next failed solution, your investors will start to doubt that there is a solution in hand or that you’re the person who will lead the company to that solution. Skeptical team members will look elsewhere for jobs. Doubt will slowly kill the company.

Below are the keys to surviving the patient stage.

Keep it short. First and most obvious, the shorter each patient stage the better. As long as there is clear forward progress, things start to get a lot easier. It’s extremely valuable to demonstrate the small wins. An overall sense of constant movement against the key challenges will build confidence that the company is getting closer and the patience is well-deserved. Having emerged from previous patient stages and achieving a new level of success, will actually make the company more resilient through the next patient stage.

Stay aligned. Second, it’s important to be precise with your board and team on what problem the company is solving. There are few things more frustrating than finally feeling that you’re making progress only to realize that investors, founders and team members had a different view of the problem to be solved, and many don’t agree that the company is progressing.

Don’t develop product myopia. Third, while sharing product progress, don’t overestimate investor reaction to product. Remember investors aren’t product experts. They’ll typically react positively to any product hypothesis that they believe will move the company forward, but be careful not to keep showing them product iteration after iteration, only to keep getting poor customer results from each new iteration.

Product iterations are hypotheses and not progress. Investors will likely be tempered in their enthusiasm until they are seeing results. At some point, seeing the next version, after many previous underperforming versions, will lead to a loss of all credibility and investors will think that your strategic product instincts are not going to get the company beyond this stage.

Don’t fundraise against patience. Avoid fundraising at all costs while in the patient stage. Your own investors will struggle to write a check and even worse they will lack the confidence to inspire new investors to write you a check. When fundraising, it is important to anticipate that things can go wrong and that you will likely find yourself in the patient stage at some point.

Plan accordingly and raise enough during periods of great optimism to fund the company through purgatory. The combination of being in the patient stage and also running out of money can be a death blow to startups.

It’s a matter of survival. I’ve seen companies stay in the patient stage for a few years and others that cannot survive through this stage for more than a few months. The patient stage is inevitable, and it is the riskiest phase in terms of how the relationship between investors, founders and team members can impact the success or failure of a business.

Erode credibility during this phase and investors and team members will lose patience and throw in the towel. Collaborate well, be clear on the problems and the planned solutions, show steady progress and you will sustain through the patient stage for however long is necessary.

Conventional wisdom is that startups are bought, not sold. The logic follows that no matter how much an entrepreneur wants to sell a company, there needs to be an eager buyer and no amount of seller desire can manufacture one. Some people interpret this wisdom to mean that they should spend no time getting to know buyers and when a large company is ready to buy their startup, they’ll come knocking.

I understand this advice, but had very different experience selling Brontes Technologies, a company I co-founded with Micah Rosenbloom that brought mass-customization to the dental industry. The process started without a buyer and ended with five.

Strategic Fundraising Can Test the M&A Market

We were starting the process of raising our Series B financing with a beta product and no revenues. Micah and I believed that we had a game-changing technology for dentists, but that the venture capital community would undervalue it, because we didn’t fit into an easily defined category, like enterprise software. No matter how much we tried to convince VCs that enabling mass customization in dentistry was a big economic opportunity, even the most excited investors would put a discount on a market that they didn’t know well.

Micah and I decided to seek out strategic financing for two reasons. First, we thought a strategic investor could help financial investors understand the potential value of the business. Second, I commented to Micah, and truly believed, that “if only we could get someone to fire a shot, there would be a war to buy the company.”

We had no specific intention to sell the company at that moment, but we saw eager acquirers as offering the company meaningful optionality on valuation, and we wanted to build momentum around potentially being purchased at some point.

Get to Know Potential Buyers Early and Often

We had invested time over the previous two years getting to know key industry players. The head of corporate development at each of the companies in dental tech had likely told their CEOs that they were staying close to Brontes and would get a look if we were interested in selling. I think this was one of the most important investments we made when it came to selling the company.

Companies may be bought in a moment, but they are sold over time.
These industry players knew us reasonably well. We weren’t calling them cold to offer them an opportunity to invest in a company that they never heard of. While we were somewhat coy with senior folks from the industry, we had done a good job creating a positive reputation as a team building something that could be important to the future of the industry.

When we approached three industry players to offer an opportunity to invest in our round, all three wanted to pursue diligence and ultimately all three offered to invest. While we weren’t certain we wanted strategic investment at the start, we became convinced over time that one of the strategies offered great upside of having an industry investor with minimal downside.

Incite a (Bidding) War

Coming to agreement with that strategic investor to lead our Series B was the shot that started the war. When we told the other two strategic candidates that we decided to take capital from a competitor, they were both very upset.

One flew up that same week to meet us for dinner to convince us not to take the deal. He looked me in the eye and said “what can we do to get you to walk away from the other deal and take money from us. We can definitely beat anyone on valuation.”

I responded “It isn’t about valuation. We are afraid that a strategic investment from you could hurt our opportunities to work with others in the future and are convinced this isn’t true of the investor that we’re accepting. Absent an offer to buy the company for more money than has ever been paid in this industry for a pre-revenue company, I don’t really think there are alternative ways for us to work together right now.”

They made an unprecedented offer to buy the company the following week.

Sell Without Selling Out

Getting to know all the big players in the industry over the past two years was paying off. So we took that first offer and immediately called the other potential buyers to tell them that we had an offer to sell and didn’t want to do so without speaking to them first. We’d need to know quickly whether they were serious about buying the company and what they could offer as a price.

Two weeks later, we had the war for the company that we imagined. Five buyers bid to purchase Brontes. While 3M wasn’t our first choice when the process started, they did an amazing job helping us see the potential to build Brontes on their platform. By the end of the process our management team was unanimously convinced that we wanted to be part of 3M and an offer for $95 million sealed the deal. The price war had driven up the value of the company nearly 50 percent from the first bid.

Could any of this have happened if no one in the industry thought what we were doing was important and potentially of interest for acquisition? Certainly not. Having said that, the process didn’t start with a buyer and it ended with many.

Selling a business is a process that is executed with a long view and years of preparation. It’s important to get to know buyers well before a company is interested in selling and build mutual respect over time.

Companies may be bought in a moment, but they are sold over time.

After struggling for months or years without any financing, most startup founders relish the opportunity to finally have the seed capital to accelerate the plan.

The first term sheet often feels like such a big accomplishment, not because the founder confuses the funding with success, but because the period before funding feels so excruciatingly slow. Hitting the gas is a dream come true.

Like sand in an hourglass, funding will relentlessly disappear, along with the opportunity it presents.
Unfortunately, the challenges of that opportunity are often unclear at that moment. Capital, no matter how much is raised, is finite. The day it hits your bank account the clock starts ticking and no one (including the founders) ever wants to work for free again.

Like sand in an hourglass, funding will relentlessly disappear, along with the opportunity it presents. At the moment of financing, this seems like a very high-class problem, until it isn’t, and it becomes a very real problem.

At first the team is small and the initial burn rate barely moves the dial on the capital raised. Then the founders start to determine market salaries for their talents. This is a dangerous moment. No one wants to feel underpaid, and how big a deal is an extra $10K a month to the company’s burn rate when one or two million dollars just hit the bank account. Beware this moment.

Every dollar the founders take out of the company sets the tone for the entire business going forward. Every dollar spent is a dollar of dilution, as it costs equity. Every unnecessary dollar spent on the founders sets the tone that cash should be more important than equity to everyone involved in the business.

Every dollar spent is a dollar of dilution.

Then the hiring begins. The money wasn’t raised to stay still, but to invest in accelerating the plan. Talented people who couldn’t join pre-funding are now interested and can be game changers for the business, but they can’t leave their jobs for less than market salaries. Equity tradeoffs? For sure they’ll trade minor dollars for major equity, but few will make equal tradeoffs of cash for equity.

To get those talented people, the founders believe they need a fun place to work and paying a little more than expected monthly for a nice office is money well spent on culture and team.

Those talented leaders join the company, but they too want resources to meet the ambitious plans. They start articulating key capabilities that are needed, and they put together job specifications of who to hire to solve those problems. Unfortunately, those people are hard to find, so after paying a handful of recruiter fees and ponying up much more in salary than was planned, you finally have an all-star team fully built out prior to raising Series A.

The problem now is that the original 15 months of capital you raised will be burned in less than 12 months. Worse yet, six of those months have already passed and the company is way behind plan because it didn’t have the people it needed to stay on course. The company will be out of cash in six months and needs to start thinking about raising money. The founders figure fundraising will take the typical three to four months – so in two months the fundraising process needs to begin for Series A and there is little to show from the seed financing besides a great office, and hopefully, a talented team.

So what’s a good founder to do? Not take any salary? Not hire any people? Never pay a recruiter fee? Have everyone work virtually? I wouldn’t recommend any of those options.

This tyranny of incrementalism often comes from founders confusing investment with progress.

I would recommend that the founders stay mindful of the tyranny of incrementalism— every small decision itself will feel rational, but in aggregate those decisions burn your scarce opportunity. Like a frog who would jump out of a pot of boiling water, but boils to death when the temperature is slowly raised to a boil, many founders find themselves in peril in the same incremental way. Looking back, they cannot believe how quickly they burned capital, but in the moment every decision seemed like the right one.

This tyranny of incrementalism often comes from founders confusing investment with progress. Remember, building evidence toward the company’s hypothesis is the purpose of the seed funding and there are many ways to do so. Often this can be accomplished with very little capital and yet founders frequently overly invest early. Be careful not to burn your own opportunity.

Taking the leap to being an entrepreneur is really scary. Every founder that I know points to role models that made that leap possible. Some of those role models are legends like Steve Jobs or Alfred Sloan. While legends inspire us at a high level, their path also seems unattainable to most of us. We read about them in biographies, but cannot relate to them as people. Another type of role model comes from those that we directly identify with as peers and inspire us to believe that we can also be as bold as they are in aspiring to achieve our dreams.

When I was working as a strategy consultant, and miserable in my very incremental daily routine, I dreamed of starting a company, but was unsure if I was being realistic. I was inspired by the legends, but following in the footsteps of Jobs felt inaccessible to me, like trying to follow in the footsteps of Michael Jordan or Tiger Woods. Just because I admired them, didn’t mean I had any chance of becoming them. Two role models stand out in my mind as people who I related to as peers and gave me the courage to believe in myself as a founder.

One of those people, I didn’t know personally at the time. Todd Krizelman was the founder of I first encountered Todd along with his co-founder on the cover of a major magazine in 1999, held up as a symbol of the new economy. He was approximately my age and we knew people in common. I remember staring at that magazine cover and thinking how awesome it was that someone my age, with a similar background, was betting on himself and succeeding. Fixated on that cover, I couldn’t help but question why I was sitting still and not even trying to achieve my aspirations.

The other role model that stands out in my mind was a friend, named Josh Schanker, who went to a neighboring high school. I met Josh through various high school activities and thought really highly of him. We stayed distantly in touch while at different colleges. When I heard that Josh became Editor-in-Chief of the Harvard Crimson, I wasn’t a bit surprised. I always viewed Josh as a talented and thoughtful leader. Like me, Josh also graduated and went to work for a consulting firm. He then paved the path that I was struggling to muster the courage to take and founded a company called BargainDog with a friend of his named David Beisel.

Not long after, I quit my uninspired job and founded a company myself, but I’m not sure I would have done so without Todd and Josh showing me that it was possible and giving me the courage to bet on myself.

Life has a funny way of coming full circle.

In 2007, I got the opportunity to invest in a company founded by Todd Krizelman called MediaRadar and have been a very happy investor ever since.

Today I’m proud to announce that I’m leading an investment in Josh’s company Bookbub.