First rule of entrepreneurship: Don’t raise money!

MoneyI recently met up with a start-up that just closed their first VC investment and who were naturally really excited.

My initial comment threw them a bit off.

I said: “Congratulations – you’ve just decreased your chances of success to about 10 percent”.

I am sure this was not the answer they were hoping for, but if you look at the statistics this is nevertheless the truth.

When you sign up with an investor you have to remember that investors expect to have one or two really big successes in an entire fund.
The remaining investments will – at best – pay back the investment or go bankrupt.

The sad story is that in Europe around 45 percent of all capital in a venture fund ends up in companies not paying a dime back to the investors.  And when you look at it this way, you could say that raising money basically increases your venture’s risk of failing.

There is a very logical explanation to this.

Getting money onboard usually means that you are expected to do more and faster, so you start hiring new people which increases your burn rate significantly. But if your results in terms of customers and revenue do not follow your expectations, it will take time to slow down and you run out of cash with little chance to get to a lower burn rate. In most cases your investor will also be pressuring you to maintain the burn rate and just perform better.

There is a tendency to focus a lot on raising money and getting investments onboard. But remember that money is not the goal in itself – it is the means to an end, whether that is developing your product, increasing marketing, sales activities, etc. There are other ways to get all of those things.

Before a startup gets an investment they do a lot of things: Assemble a founders team, build a first version of the product, get the first customers onboard, etc. And most companies can get to the next level by doing the same – get commitments from people who think the company or product is exciting and wants to add a bit of resources, first customers willing to pay upfront, etc. And these commitments are usually of much higher value than money in itself because they drive learning, insight and understanding.

I am not saying that you should never go for the money – I am only saying that you should think of your startup as series of small experiments that you are testing. Experiments that will either be successful or not and experiments that you can abandon if they turn out to be less promising than expected. Experiments that can be abandoned fast which will get you back to a lower burn rate and get you ready for the next set of experiments.

Do not bet all of your money on one strategy but think of your startup as series of options that you can pursue with little knowledge as to which of them will be the right one. And reserve cash for the next experiment and the next learning cycle.

In my mind startups do not fail due to lack of cash but lack of learning and lack of speed in learning. Not all your experiments will be successful but if they increase your learning and understanding on what to do next, they have increased the value of your company because risk has been reduced.

I know it is hard to convince an investor that you would like one million and that you will spend it on designing experiments and obtaining learning in order to deliver the promised results. On the other hand it is so much more credible to talk about your assumptions, how you will test them and what you will do next if the results are not as expected. The smart investors will get that.

And always remember: In Europe only 17 percent of all fast growing companies are based on venture capital.

3 thoughts on “First rule of entrepreneurship: Don’t raise money!

  1. The first which pops into ones mind is normally also the right one – your initial comment is very right.

    Your second comment is also right – when funding arrives in millions, the company owner begins to spend more than he would normally do, which is caused by the VC not having a clue what they are doing, and not guiding the company sufficiently – else the company wouldnt blow their budget.

    Your second comment is missing, which is about the VS´s themselves. Many VS´s like Accelerace are some strange constellations, giving an impression of a “random walk” business, aimed not at being a core VC, but to milk funds from EU, the investors, and the companies they “select”. Looking at the portfolio of Accelerance, not mentioning any company names, it is obvious that not even basic desk research was done selecting as to technology, competitiveness and market positioning – or the staff at the VC has got a clue how to analyse a tech company.

    Which is a general problem with many VS´s, they do not have the qualifications to be a VC, and they are a random walk business.

    Together with similar companies in the VC business, they are a “traveling circus” where the “lucky” innovators have to travel around and use time on being part of a show, for the VC´s to demonstrate expenses to the EU and the others funding the – 200 hours x 34 companies = 6800 hours x 500 EUR = 3.400.000 nice solid EUR.

    So for many VC´s this is not about beging a VC, but about milking money.

    A true VC definers where he wants to be, in which sectors, he makes an analysis, and screen the market for promising upcoming companies as to this PLAN. He pics the company.

    • Thanks for your comment. In my mind the quality of any investor should be judge on one thing and one thing only. The ability to return money with promised interest. Good investors return money with interest – not so good investors do not. Even the best investors in start-ups have more failures than successes. So picking the winners seems to be hard – even for the best investors in the market. I am no expert on VC’s – hope to be it one day. My only point is that money is not the goal for a start-up it is and should always be seen as a mean, and my point is that a start-up should always be focused on the goal and take any mean into account to get to that goal and maybe money is not always the right answer.

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