What Keeps Founders Up At Night

Something I ask most startup founders is…

What keeps you up at night?

One of the more common responses: running out of money.

I get it. Even with Silicon Valley pouring more capital than ever into startups, most founders still find it incredibly challenging to raise money. Nor are they sure how much longer the startup space will be flush with cash.

Another cause of insomnia that founders mention? Scaling. (We covered scaling in our article “What Seed Investors Should Look For.”)

It’s the fear of the unknown, combined with a sense of urgency. One founder recently told me, “We need to scale and I need to make it happen as soon as possible.”

Again, it makes sense. You can’t become big without scaling. Until you scale, most venture capital companies peg you for the minor leagues.

But these issues aren’t as straightforward as they might seem…

The Downside of Lots of Cash

I don’t blame founders who raise a little more cash than necessary. And I especially like the idea of using that extra cash as a “rainy day” fund – for emergencies and unanticipated scenarios.

What’s more, startups may need to use that extra cash when investors stop lavishing them with globs of money. Or as a safety net allowing them to take more risks in juicing revenue growth.

Listen, I’m not advocating free-wheeling spending. Those risks should be weighed carefully. Assuming they are, the downside of having too little cash is more serious than having too much.

The ultimate downside is running out altogether. Believe me, it happens. Many startups struggle to survive when investors become cautious or fearful.

It’s harder to recover from running out of cash than from a little extravagance stemming from sitting on a pile of money.

Yet, raising too much cash does have a downside. One VC investor who shares this view is the always interesting Mark Suster of Upfront Ventures. Hard to dispute his points.

He says raising large amounts can push up valuations. He’s right.

More megarounds – investment rounds of $40 million and more – are being raised in 2015 than in any other previous year. Valuations for such rounds usually don’t fall below $200 million. And they can reach $1 billion (the vaunted “Unicorn” status) or more.

He also argues that large amounts raised along with high valuations can heighten growth expectations beyond what startups are capable of. I see this happening more in the later rounds than early ones. But I’ve also noticed some “valuation creep” setting in at the early (pre-seed and seed) and middle stages (Series A and Series B).

The reason: As valuations escalate in the later rounds, investors are migrating down the funnel to earlier rounds to access still-reasonable prices. More demand is leading to higher prices.

What’s more, says Suster, too much cash can make startups careless. Okay, I’m sure Mark has seen examples of this. So I’m not disputing it. But I haven’t encountered much of this behavior in my dealings with founders. So I wonder just how widespread it is.

As for scaling…

Timing Is Critical

Getting the timing right is critical. Again, Suster has strong opinions.

He warns against scaling in the absence of product/market fit. If done too soon, he says, it can bloat such key metrics as customer acquisition costs.

On the flip side, putting it off because you don’t have enough cash is inexcusable for startups that have already found product/market fit.

Suster says, “I know in my bones that there is a magic moment where capital plays a hugely differentiating role. As in back up the truck, load on $20 million to $30 million and let me blast the market with all I’ve got.”

I agree with Mark on scaling. Just look at what GitHub is doing…

GitHub is a $2 billion cloud-based management service for software development. It had four years of profitability. Then it raised two rounds totaling $350 million.

Too much money? Not according to CEO Chris Wanstrath.

The company is now plowing that cash into growth. But, he says, the company could return to profitability if it had to.

I couldn’t agree more with Wanstrath’s strategy. If it doesn’t work, so be it. But the bigger sin would have been pleading poverty and taking a pass on scaling when that “magic moment” arrived.

These are not only important issues for founders but also for investors looking for reasonably valuated companies on their way to scaling, i.e. experiencing explosive growth.