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More in the 50 Questions Series50 questions: Should I let my lawyer negotiate the deal? | 50 questions: Should I hire an adviser? | 50 questions: What does an LP look for in a venture capital fund manager? |
50 questions: Why too much money will kill your company
Together with Nic Brisbourne of The Equity Kicker / DFJ Esprit, I am writing a series of 50 questions you should ask when raising venture capital. We expect the series to run for a year, after which we will collate the answers into a book. We view this as a collaboration, so please comment to help make this series even more useful. This is post #12 in the series.
Can there really be such a thing as a startup raising too much money? Of course there can. The history of investment is littered with example of companies that raised too much capital, were feted by the press, government and investors and then imploded before their products had made a dent on the market. From the games industry, the most recent example is RealTime Worlds, which raised $104 million and closed a few weeks after it launched its magnum opus, APB. During the dot com boom, there were many examples, but perhaps the most egregious was Boo.com, which raised $135 million, spent it all within 18 months and went bust without having really launched a product at all.
Why is having too much money bad?
Having too much money is bad because it stops a startup from fulfilling its primary function: to iterate its way to product/market fit. In a previous post, I explained what product/market fit means, and why it is so important to a startup. I hope it will quickly become apparent why too much money is detrimental to the process. Finding product/market fit is about iterating. It is about changing the product, the business model or even, in its most radical form, the entire target market, in response to feedback from customers. I’m not for a moment suggesting that a startup CEO needs to respond to every crazy idea of every customer. He or she needs to use face-to-face conversations with customers, detailed analytics, feedback from the sales and marketing teams and every tool in the workshop to understand where the perfect confluence of product, market and team occurs. He or she then needs to reshape the company to deliver on that confluence. That can be a very scary process. ngMoco CEO Neil Young pivoted away from paid-for games on the AppStore because he believed that he could not achieve meaningful scale as a games business given the rapid downward trend in pricepoints. He abandoned a business model that was currently profitable for his company based on his belief (and copious evidence) that transitioning to a business model that was free with microtransactions satisfied the market need much better – and would be much more profitable. Eighteen months later, he sold ngMoco for $400 million to DeNA of Japan. The concept of pivoting may be overused in 2011 (see this New Yorker cartoon), but it is a useful one. It is a phrase that allows startup entrepreneurs to say not “we failed” but “we tried, and learned, and are trying again.”
Change is scary, and money makes it unnecessary
Companies with lots of money don’t need to pivot. They can tell themselves that the problem is with the sales team, or with customers not understanding the product, or with usability issues. They tinker under the hood instead of understanding the market. They spend money on a sales force to pitch, instead of forcing the CEO into the marketplace to hear from his prospects why they are not buying. They execute, execute, execute. Against a business model that does not work. Raising money is a great thing. Having lots of it is a wonderful comfort. But for a startup trying to find its place in the market, it can be disastrous.
Hungry for more? Go to the 50 questions homepage for more insights into venture capital.