Why Less Is More for Startups
That's the refrain I grew accustomed to rattling off when I was getting my tech startups off the ground. I now hear it with increasing frequency from nervous entrepreneurs who can't find capital and want my thoughts on what to do. I always respond with the same three-word phrase: Less is more.
Yes; it's a cliché. But it's the best piece of survival advice for young companies, bar none. When a company is running on a tight budget, it will perform far better than a company that has gotten a chunk of cash from VCs. While this seems like common sense, it's actually news to many entrepreneurs (and aspiring entrepreneurs) who learned that raising venture capital is essential for high-growth companies.
Seasoned Pros Want Perks A growing body of research implies that the correlation between raising money and success of startups has been exaggerated. In a study released this month of 79 tech companies funded over a 10-year period, David Townsend, an assistant professor of entrepreneurship at North Carolina State University, along with a co-author, professor Lowell Busenitz at the University of Oklahoma, found that a venture's success isn't necessarily dependent on funding. "Contrary to conventional wisdom, undercapitalization is not a death sentence. We found that moderate levels of undercapitalization—even capitalization ratios as low as 20% of the venture's initial goals—are not statistically related to a venture's probability of surviving. What appears likely to matter more for these ventures is the creative transformation and use of resources at hand and a disciplined approach to cash management," says Townsend.
And in my own experience, landing equity money early on quickly leads to bad habits.
First, a CEO will usually feel pressure to bring in a "grown-up" management team. But seasoned managers want big salaries and large chunks of equity. VCs usually expect a portfolio company to use a preferred headhunter to find the rock star VP of sales. Naturally, the headhunter also wants an equity stake, on top of a finder's fee in the neighborhood of six figures. When the rock star manager arrives, he or she expects rock star perks—an assistant, first-class travel, etc. Now imagine these distractions aren't limited to one new hire but half a dozen or more. In my own experience, bringing in a new team meant remaining members of the original team stopped worrying about keeping costs down and didn't care as much if a sales cycle stretched out longer. And the new hires were eager to embrace this unhealthy attitude. It's an attitude that can quickly cripple and kill any new venture.
Putting Profits Ahead of Growth Second, bringing in outside money usually creates expectations of very rapid growth. VCs want a home run, not a single or a double. And they want the home run within five years or less. But founders, not outside investors, should determine the proper pace of growth for a company. And a founder who is about to lose his or her life savings is far more likely to drive a company towards profitability. A founder in this position turns every person in the company into a salesperson—and that's the best model for a scrappy startup. In the end, creating a culture that emphasizes long-term profitability over rapid growth is critical for success.
Furthermore, in an economic downturn like the current one, increasing sales quickly is far harder since consumers and businesses are spending less. So a focused, eager team is essential.
When my company accepted outside money, I saw staffers' and board members' focus shift to boosting revenues quickly but not necessarily sustainably. It was harder to maintain customer relationships built on trust when we also faced expectations to sell as much product as possible as quickly as possible, even though customers might not need it.
Hard-Learned Lessons Yes, sales folks should be hungry. But they should also take a long-term view on customer relationships and push for profits rather than top-line growth.
Third, outside money means that founders spend less time thinking about customers and more time thinking about keeping the board of directors happy. Founding management is invariably far closer to the customers than the board. And the more time and focus management can direct toward customers, the better. The outside money blurs the perception of who pays the bills. In the short run, it may actually be the VCs who just sunk a chunk into the company. But in the long run, it's always the customers.
I experienced much of the above as a startup CEO. As soon as the big venture money came in, I began spending way more time than I should have worrying about justifying my actions and focusing on the results I would report every quarter in our board meetings. That took away from my focus on making my customers successful. We had to accelerate our development plans and to diversify our product portfolio as we had promised we would do with the money we raised. Ultimately, the outside money made it harder for me to do my job.
Hungry Teams Get Results None of this is to say that a board and talented VCs can't be a huge asset. And sometimes a big injection of capital is required for fast growth. Bringing in rock star management can give a company added boost and lift fundraising if, for example, the company is truly running on fumes and is almost out of options. Both helped me, to some extent.
But I will still take an inexperienced, hungry, cash-strapped startup team over a well-oiled team of Google (GOOG) or Microsoft (MSFT) veterans any day of the week. Hungry companies figure out ways to keep eating because they don't know whether there will ever be another meal. Industry veterans and serial entrepreneurs worry less about failure and are therefore more likely to fail. This, in a nutshell, is why it's so hard to find examples of people who have grown more than one company to considerable size.
And this is also why less money means more chances for success at most startups. So don't worry if you think you don't have enough capital. Instead, be grateful for the sense of urgency.