5 legit reasons to raise funding for lean startups
Concerned you might be not lean if you raise funding? That’s actually a pretty common myth related to the Lean Startup approach.
Let me ask you this.
Have you ever received a “recycled” present?
While it’s clearly new, it doesn’t actually match your interests. In fact, you know that the giver received that present from someone else a few months earlier. It’s likely, therefore, that they never opened it, and just gave it to you.
That’s similar to the day-to-day experience of a tech startup investor. I actually worked at a VC fund in the past. More on that in future emails. Download a free chapter of Launch Tomorrow to get in on the action.
Many times a day, VCs get pitched equity in a tech startup. The founders don’t want the equity. They prefer cash. This immediately reduces the equity’s perceived value, in the VC’s eyes. In some cases, screams desperation. If the founders, who have lots of equity they got somewhere else, are willing to give it away…what does it say about the company’s value? About its prospects? About what the founders believe about the company?
A common question that I get from people first looking at tech startups is why tech startups need so much money. After all, it shouldn’t cost that much to throw a product prototype together. Isn’t it all just self-serving hype?
There are five strategic reasons to raise money in the tech startup world:
- Funding customer acquisition
- Hiring top talent
- The “land grab”
- The “pre-emptive strike”
- The cash flow shortfall
So, starting from the top.
In all but a handful of businesses, if you can’t buy customers, you don’t have a business. Sometimes an idea takes off and goes viral. For the mere mortals out there, though, you need to figure out how to acquire customers and serve them profitably. Paid advertising, in particular, has a bad name because it’s easy to misuse with other people’s money. It’s easy to fool yourself and others that something is happening, unless if you know what you’re doing.
Admittedly, most investors aren’t keen on providing money just to acquire customers, unless if you have already proven you can do this. Turn $1 into $4. Or $40. A marketing expense can reliably generate profit.
Recruiting talent to help you execute also costs money, particularly if you are breaking new ground technically. Figuring out how to scale certain technical problems (like search or constructing social graphs) requires serious technical chops. The number of software engineers capable of doing that is pretty small. And the first guys who scaled Google, for example, were self-taught.
Moreover, to be blunt, the guys in most cheapo emerging markets live in much smaller markets. They’ve never had to solve these problems in their home country. So you need to hire smart people and keep them happy.
Now–we get to the really good reasons why raising money is a good idea. The strategic ones. If you and your competitors are creating a completely new market, there is a land grab going on. Whoever can get the most market share–wins. There’s an old rule of thumb from Davidow who ran Intel’s marketing during their high growth phase. Having at least 30% of market share leads to consistent profitability in most niches. At that point, you can influence what happens.
Until you get to that point, you’re a commodity vendor. So while it can be a bit abstract, getting a strong footing in a niche will help establish you as a player. If you’re in a niche where this is happening, suddenly paying for growth has whole new meaning to investors. You only need to be a little bit better to beat out the competition, after all.
The pre-emptive strike is similar to the land grab, but more defensive. Let’s say you are a cheeky bootstrapper. You enter a market adjacent to niches already inhabited by companies with deep pockets. You’ll be at a loss when they decide to enter.
For example, Google entered the search market, knowing there were a lot of well-funded competitors at the time. Yahoo, Lycos, and Altavista to name a few. Moreover, there were big tech players like Microsoft who had kind of missed the boat, but still had a lot of money. They could catch up quickly if needed.
Think Bing. If Google had tried to bootstrap their way into the market, despite having better technology, they could have lost. Instead, they got funding. They built their technology to be completely scalable, while building up goodwill with users. Then, after 6 years of funded growth, they finally introduced advertising to monetize the growth. In 2004, they launched Adwords.
Last but not least, there’s the cash flow shortfall. This is more common in tech companies that combine hardware with rapid scaling. In essence, though the same financial problem happens across the sector. There’s a long list of well known companies which blew up, despite having a sales growth trend: Osbourne, Spectrum. That’s right. High growth, high sales, high profits, yet low cash inflows.
If there is a long time gap between a sale and getting cash, the company won’t have enough cash to fund operations. Scaling their operations becomes impossible without that. You may need an exponentially growing staff to service your exponentially growing revenues. You need inputs like parts for a hardware company–also at an exponentially growing pace.
Unlike in software, manufacturing at scale is complicated and costly. Should you think this is a throwback issue from the 1970s, what about the Internet of Things? What about hardware startups today?
So there you have it. Five legit reasons to raise money for your startup.
If you want to get on that path, you’re much better off using the Lean Startup approach. Don’t take external money, if you don’t need it. Stop selling yourself (and your business idea) short.
Validate your idea. With Launch Tomorrow, you can be certain that you’ve proven people want to buy what you’re selling. Or thinking of proposing. Or building.
Build the right product. Make sure you can acquire customers profitably.
Then get funding. And break out the bubbly.