Raising venture capital is hard. Once you’ve done it successfully, all of the sudden things seem really easy — you’ve got money in the bank, you get some press, employee candidates and partners perk up. Don’t be fooled though — it won’t take too long for reality to set in. Josh Melick discusses how VCs slowly and subvertly get you to overspend.
As founders, we are optimists. We have to be. To risk starting a company, along with selling our vision, and convincing employees, partners, and capital providers to come along for the ride. This vision requires endless optimism in spite of (often) many naysayers. But we persevere through it all anyway.
So after raising a round, especially that first round or two, all the sudden we start to feel vindicated. We’ve had some success! Things that were once hard all the sudden get a lot easier. People return your calls. People have heard of you and your company. That risky startup idea doesn’t feel so risky anymore.
How Does Overspending Start?
Remember that VCs are in the business of deploying capital. Their business model is to deploy capital and get ownership. The higher the ownership, the better the model works. Power laws mean they need some big winners. Small winners don’t do it. They need big. They want you to go big – the bigger the better. They want you to take more capital. That is how they win.
Now, that doesn’t mean VCs will be outwardly upfront about this or overly pushy. And they all talk about how founder-friendly they are, etc. The process is much more subtle than that. In a board meeting, it tends to go like this:
Founder: “I’ve got this crazy idea on how we can drive up distribution. We can partner with XYZ companies. We can revshare. With enough in place this should work. It’s a long shot, but we’ve got a small version of this working already.”
VC: “Interesting idea. I saw it work at this ABC portfolio company. This part was hard but it did end up panning out. I can intro you to them to hopefully learn from their mistakes and apply it more broadly here.”
Founder: “Oh wow, that’d be great. But I’m worried about the costs / time frame / etc. But I do think it can work. We’ll prob take a pretty cautious approach to start.”
VC: “Well we need to show some proof points this summer on growth and distribution. The next round will require more of this. I do think it’s worth a shot, so don’t go too slow. With some help here it’s very possible.”
So what just happened? The optimist founder presents a crazy idea. VC offers some genuinely useful advice, some mild pushback, but also some help. In the end, once you’ve raised capital, you end up taking more of these risks. You do kind of have to. It’s the game. You need to make bets. Having capital means you can make bets. But the optimism of the founder plus the general encouragement from the VC means the bar for those bets is lower than it once was. This leads to overspending.
Fast forward a year.
That bet didn’t work. It cost 2-3 hires, some marketing budget, some mindshare. But it was worth it, wasn’t it? And thinking back over the conversation, no one did anything negative. It was a healthy dialog. Except it was generic advice, generic warnings, a simple introduction, and yet no real pushback that would have proven valuable. Repeat this process a few times, and much of your initial capital gets burned up.
Venture funded startups are rocket ships. Venture capital is rocket fuel. Rockets and rocket fuel are extremely flammable. VCs want to add more fuel. As founders, we need to check our optimism. Someone needs to push back. The discussion above could be much more valuable if it included one or two outside and knowledgeable opinions who aren’t selling dollars (the VCs) and who aren’t overly ambitious optimists (the founder). A good, independent board member can (and will) check those two biases.
Don’t get confused or be naive. The VC would rather see an extreme outcome — success or a fire sale — than a slow and mediocre company they don’t know how to value or how to exit. They will push towards those extremes, even if in only subtle ways like my example.
Conclusions: Watch your spend like a hawk. Find other advisors to check your ideas, less so your VCs. Hire slow and fire faster. Don’t be afraid to push back on VC advice. Remember your bias and their’s. Obsess over the details! Good luck!