This post originally appeared in TechCrunch back in 2015, written by our co-founder and managing partner Erik Rannala. We believe the message applies as much today as it did in 2015 when it was published.
Some entrepreneurs think that (more) money will solve all their company’s problems. It won’t. Like a teenager with a million-dollar allowance and an identity crisis, a startup with too much capital and no product-market fit will become capable of making larger mistakes.
Biggie Smalls said it best: “Mo Money, Mo Problems.”
As an investor, I root for startups. It pains me to see great teams and ideas collapse under the pressure that sometimes follows fundraising. If you’ve raised money and you’re not sure what comes next, that’s fine – I don’t always know either. However, I do know four things you absolutely should not do:
1. Scale too quickly
If you invented a new type of parachute, you would test it rigorously and then jump out of a plane. Startups flush with cash often do the opposite – they jump out of the plane, and then test the parachute as they free fall.
Compass.co, a benchmarking and research service, analyzed 3,200 internet startups and found that 74 percent “fail due to premature scaling.” These lost startups land higher valuations, have larger teams, outsource more product development and spend more money on customer acquisition than their peers.
Before you indulge in marketing, sales and blinged-out offices, find product-market fit. How do you know you have it? If you put $1 into marketing and get $2 back, you have product-market fit. Test your sales and marketing a few feet from the ground, first – not from an airplane.
2. Hire the wrong people
Bad hiring decisions are often a symptom of premature scaling. Why hire a sales team when you have nothing to sell yet? That sounds absurd, but founders convince themselves that they’ve hired the right people at the right moment. Have you ever read a press release that says, “We spent a ton of money on new hires, and it could work out. Honestly, we don’t know.”?
Until you have product-market fit, hire builders: engineers, designers, and growth and product people. Test sales, marketing, and growth strategies on a limited budget. Be trigger shy about hiring. Do you have enough work for a fulltime visual designer or can you get by with a contractor?
Be prepared to let people go. If you burn all your cash on the wrong people, it’s game over. Consider that the most humane and wise choice might appear ruthless at surface-level, but it will be the best decision for everyone in the end.
3. Cling to the Wrong Idea or Give Up Too Quickly
“You got to know when to hold 'em, know when to fold 'em,” as Kenny Rogers said. It’s an art. When Manny Pacquiao and Floyd Mayweather squared off on May 2, Pacquiao clung to the same strategy the entire match and lost as a result. In comparison, the founders of companies like Airbnb and Pinterest stuck to their same core ideas for years of rough going and succeeded. Had they decided their ideas were invalid, they wouldn’t have the multibillion-dollar companies they do today.
You may think you have so much cash that you can afford to keep testing new ideas until something takes off rapidly, so you invalidate them too quickly. Or, you feel like you have so much cash that you can afford to burn it until your original idea eventually works. Funding can fuel both flawed mindsets.
Sometimes founders misapply lean startup methodology. They run a few micro-experiments and immediately kill their idea if results come back negative or things don’t immediately take off. Remember, your interpretation of the experiment matters as much as the results. Is your problem the market or the product? You can’t force customers to want solutions to problems they don’t have, but you can fix a flawed execution.
4. Lose focus
Founders assume that their plans will unfold exactly as they envisioned now that they have money to execute them. As the great philosopher Mike Tyson said, “Everyone has a plan until they get punched in the mouth.”
As the plan goes awry, founders lose focus and can’t adapt. They start to get distracted with projects and initiatives that aren’t mission-critical. Particularly if the company scales prematurely, founders will get lost in the day-to-day minutiae of superfluous projects, staff, and office space they needlessly bought.
Fresh off a funding round, stay focused. The main thing is to keep the main thing the main thing.
Cash, like oxygen, is your lifeline. Like oxygen, it also can become deadly under pressure. At 218 feet of seawater, the oxygen in a scuba tank of regular air becomes toxic to the diver. At just 10 feet beneath the surface, a tank of 100 percent O2 becomes dangerous.
Founders with tons of cash want to dive deep and aggressively, which can poison the company that much quicker. In comparison, founders with a tight budget dive carefully and ultimately make it to a deeper depth.
Although many companies can raise seemingly infinite amounts of money today, this isn’t necessarily for the best, and it’s changing. For all the chatter about the next “unicorn,” there is as much hushed talk about dying unicorns. As journalist Erin Griffith recently reported, “dying unicorn” lists are being passed around in investor circles. The anxiety is growing so intense that CB Insights is now charging $6,895 for its own “List of Early-Stage Tech Startups Running Out of Cash (Dying).” More and more investors have begun to shun high burn rates.
To be clear, I’m not suggesting that you stockpile capital. Hoarding is not a solution to premature scaling. Move quickly but spend sensibly.
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