There Is Such a Thing As Too Much Cash
Having lived through the dot com boom and bust, I saw firsthand what happens when startups has too much funding. Luckily we are far removed from that situation. It takes less cash to get started, methodologies exist to help get customer traction more quickly, and overall we just seem more sober about the process. While there are a few outlier startups that receive thoroughly unjustified troughs of cash, it was not that long ago that most startups were funded based on nothing more that napkin scribbles.
When times are lean, we are forced to do some belt tightening. When you are forced to bootstrap, you are more watchful of expenditures and more creative finding less costly alternatives. When times are good however, it is human nature to take things easier and relax the rigorous austerity prior to getting outside funding. You become looser with the purse strings.
There are two ways this situation arises. The first is that you simply get a boatload of cash well beyond what is justified by the size and traction of your startup much like Color or Path. Generally this happens when a category is hot (photos and social), the entrepreneurs are known quantities (from Facebook, Google, Apple, etc.) and the investing environment is heating up (as in our current tech startup “bubble”).
The problem is that a startup that acquires a massive war chest suddenly goes into sprint mode in a frantic attempt to justify the investment. They rush hiring and rush product development and rush the PR blitz so as to gain exponential growth and first-mover advantage. This is not too different than the Silicon Valley mentality of the last 90’s.
Unfortunately, first-mover advantage is a myth; it is the fast followers that most often succeed. This is because first-movers do all the heavy lifting to get early adopters, but do little to build a mainstream following. Contrast that with later market entrants that ride upon the coattails of the first-movers and merely tweak the product for mass adoption. The end result of all that sprinting therefore is a crummy product such as Color that was released way too early and with way too little customer discovery and validation.
The second way you can end up with too much cash is what I call the drip approach. In this situation, a startup does not gather one big war chest, but rather is in a continuous state of fund raising. This is caused by startups that never raise quite enough in a round and need continuous injections of funding to get to product-market-customer fit. In aggregate, they have actually raised a ton of money, but never in one cash injection.
There are several problems with continuous fundraising. The first is that the process is exhaustive and distracting to the entrepreneurs. Second, you end up with too many investors that I mentioned last week. The biggest issue however is that the startup is running in starvation mode, merely limping along on life support never getting enough capital and resources to push themselves over the tipping point of traction, but always getting enough handouts to survive and show enough progress for the next cash infusion. In most cases, they end up becoming zombie startups.
What is the right amount of funding for your startup? Read my post from yesterday where I explain how to raise what you really need. If you happen to be in the envious position of being one of the popular kids with investors willing to throw money at your startup, resist getting greedy. It is okay to let your round get oversubscribed (funding above your initial closing price), just do not go overboard. Whatever additional funds that you raise can be placed in your contingency account.
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