In response to Cash Burn Rates at Startups, one of the responses was a question asking, why isn’t this just hypocritical venture capitalists overfunding reckless founders of out-of-control startups? In fairness, there is probably some of that, though we and the investors we respect try hard not to indulge in recklessness and irresponsibility. But while it’s irresponsible to vaporize cash and your company, it can also be irresponsible to NOT invest to become #1 in a big new market. Particularly now, since there are SO many more people on the Internet and SO many more businesses that can consume cloud/SaaS vs 15 years ago.
Tension: Over invest, escalate burn, risk down round, vaporize when the market turns OR under invest, starve growth, don’t win the market and implode. Why is this so important? In tech-driven markets, the overwhelming economic returns tend to go to the company with the highest market share and the winning company with the highest market share can invest the most in research and development to build the best and most advanced products. This is the prize.
Via Glengarry Glen Ross: The reward for market position #1 is 90% of the economic value. #2, a set of steak knives. #3, you’re fired.
The challenge for CEOs and boards of tech startups is to thread the needle. Make just enough of an investment to take the #1 position, but not more. Meeting this challenge has resulted in thousands of venture-capital-backed companies creating millions of jobs over the last 50 years. This challenge becomes more difficult when money is flowing freely, since more competitors get funded. It’s very tricky and requires deep judgment. BUT opting out of the race generally guarantees you won’t be #1 or even #2. It’s not a good idea either and is just as serious a risk as blowing up.
There is no single answer. It’s up to VCs, CEOs, boards, and later-round investors to think very carefully about this for each specific circumstance.