After struggling for months or years without any financing, most startup founders relish the opportunity to finally have the seed capital to accelerate the plan.The first term sheet often feels like such a big accomplishment, not because the founder confuses the funding with success, but because the period before funding feels so excruciatingly slow. Hitting the gas is a dream come true.
Like sand in an hourglass, funding will relentlessly disappear, along with the opportunity it presents.
Unfortunately, the challenges of that opportunity are often unclear at that moment. Capital, no matter how much is raised, is finite. The day it hits your bank account the clock starts ticking and no one (including the founders) ever wants to work for free again.
Like sand in an hourglass, funding will relentlessly disappear, along with the opportunity it presents. At the moment of financing, this seems like a very high-class problem, until it isn’t, and it becomes a very real problem.
At first the team is small and the initial burn rate barely moves the dial on the capital raised. Then the founders start to determine market salaries for their talents. This is a dangerous moment. No one wants to feel underpaid, and how big a deal is an extra $10K a month to the company’s burn rate when one or two million dollars just hit the bank account. Beware this moment.
Every dollar the founders take out of the company sets the tone for the entire business going forward. Every dollar spent is a dollar of dilution, as it costs equity. Every unnecessary dollar spent on the founders sets the tone that cash should be more important than equity to everyone involved in the business.
Every dollar spent is a dollar of dilution.
Then the hiring begins. The money wasn’t raised to stay still, but to invest in accelerating the plan. Talented people who couldn’t join pre-funding are now interested and can be game changers for the business, but they can’t leave their jobs for less than market salaries. Equity tradeoffs? For sure they’ll trade minor dollars for major equity, but few will make equal tradeoffs of cash for equity.
To get those talented people, the founders believe they need a fun place to work and paying a little more than expected monthly for a nice office is money well spent on culture and team.
Those talented leaders join the company, but they too want resources to meet the ambitious plans. They start articulating key capabilities that are needed, and they put together job specifications of who to hire to solve those problems. Unfortunately, those people are hard to find, so after paying a handful of recruiter fees and ponying up much more in salary than was planned, you finally have an all-star team fully built out prior to raising Series A.
The problem now is that the original 15 months of capital you raised will be burned in less than 12 months. Worse yet, six of those months have already passed and the company is way behind plan because it didn’t have the people it needed to stay on course. The company will be out of cash in six months and needs to start thinking about raising money. The founders figure fundraising will take the typical three to four months – so in two months the fundraising process needs to begin for Series A and there is little to show from the seed financing besides a great office, and hopefully, a talented team.
So what’s a good founder to do? Not take any salary? Not hire any people? Never pay a recruiter fee? Have everyone work virtually? I wouldn’t recommend any of those options.
This tyranny of incrementalism often comes from founders confusing investment with progress.
I would recommend that the founders stay mindful of the tyranny of incrementalism— every small decision itself will feel rational, but in aggregate those decisions burn your scarce opportunity. Like a frog who would jump out of a pot of boiling water, but boils to death when the temperature is slowly raised to a boil, many founders find themselves in peril in the same incremental way. Looking back, they cannot believe how quickly they burned capital, but in the moment every decision seemed like the right one.
This tyranny of incrementalism often comes from founders confusing investment with progress. Remember, building evidence toward the company’s hypothesis is the purpose of the seed funding and there are many ways to do so. Often this can be accomplished with very little capital and yet founders frequently overly invest early. Be careful not to burn your own opportunity.
Editor’s note: Eric Paley is a Managing partner at Founder Collective, a seed-stage venture capital fund that has invested in Uber, Buzzfeed, and MakerBot.