The Dangers of Premature Funding – Why You Should Think Twice Before Taking the Money

As you can read on this site, many of our smart bloggers preach the doctrine of lean start-up. Steve Blank wrote a great article on this subject for Harvard Business Review titled Why the Lean Start-Up Changes Everything. The article points out that 75 percent of startups fail, regardless of how much time, effort and funding are involved. The lean approach, the way Blank teaches it, is to test fast, fail fast and learn whatever lessons are necessary to get you to the next level. And this can often be done with far less money than you think.

I’ve been involved with a number of startups ranging from the pure bootstrap -where my partners and I were camped in borrowed office space, sitting on chairs we brought from home – to the VC funded model, where we launched with tens of millions of dollars of other people’s money (OPM). And while the outside money was comforting, it always comes with a price. Other people will have a say in how you run your company and sometimes, in whether you even get to run your own company.

Based on these experiences, as well as what I have learned from my clients and entrepreneur friends, my recommendation is to take the least amount of money possible in the early stages of your venture, for these reasons:

  1. You will spend your own money wisely. Ventures that get big infusions of cash often spend the money in ways that do not advance the needs of the business. A recent example of this is the spectacular failure of the Israeli electric car company Better Place, which took in almost $1 Billion in funding but crashed in a big way. By contrast, if it is your money, you tend to monitor every penny and make sure all expenses are productive and necessary.
  2. You won’t change your business model too often. I’ve been in a situation where a large investor forced us to change our business model instead of staying a course that I believe would have been ultimately successful. Money often comes with some loss of control and this can be a trade-off you later regret. On the flip side, there are investors who add a great deal of non-monetary support so you need to take the cost vs. benefits into account.
  3. You will set habits that serve you well as you grow. By starting frugally, you will develop a pattern of maximizing every dollar. This will help you tremendously whether or not you take funding from outside sources in the future.
  4. When you do ask for money, your valuation will be higher. This is the same principle of how the people who least need a loan from the bank are able to get the money on the best terms and interest rate. We saw this with one of our ventures where the company gave up half its equity in return for a couple hundred thousand in angel funding. The company was ultimately very successful – and while the principals could have self-funded – because they chose not to do so, their share of the upside and control were severely diminished.

For another great perspective on the “lean” model, read the article from Fast Company titled How we founded a startup with Only $600 – and why we wouldn’t do it any other way.” The author, Anna Redmond, talks about how the average startup raises $200-$300K and yet, many of these supposedly well-funded startups don’t make it. In fact, only 30 percent of startups are fully bootstrapped, where the founder supplies all the funding. A good portion of these startups not only survive, but end up accepting outside capital not for survival, but for business acceleration. And as I pointed out above, when you take money in this type of scenario, the valuation and business terms are much better for the founders.