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Funding isn't a Startup’s Biggest Problem
Startup success and failure depends on these five other things
The year 2021 will be remembered as a record breaking year for the world of startups and venture capital. The total amount of venture investment raised was $643 billion, nearly doubling the amount of funding raised the year prior. To put this in perspective, there was 10x the capital deployed last year than in 2012.
The glut of capital and a lack of places to put it has led to a massive inflow of cash into funds investing into startups. In the US alone, VC funds raised a record $128.3 billion across 730 funds in 2021, a 47.5% increase compared with the previous record of $86.9 billion in 2020.
This has in turn created a startup flywheel where valuations and startups creation are at all time highs. Based on Crunchbase data, unicorns (startups valued at $1 billion-plus) were being minted at an average of more than 10 per week in 2021. As of this month, there are over 1,000 unicorns globally, you can view the entire list of unicorns here.
While the economic outlook for this year and next is pointing towards a downturn, VC funding is still active. Many have noted the dip in global startup funding from last year, yet funding for Q1 of this year was still 7 percent higher year-over-year when compared to Q1 of 2021. What is happening is that inflation fears and public market pullbacks have stifled late-stage funding. For seed stage companies however, they are as flush as ever with funding as the late-stage funds pour into seed and series A rounds.
When I jumped into startups, it was during the financial crisis of 2008. When talking about downturns, that was the real deal. Nearly all startup fund raising stopped as we wondered if there would even be an economy by the end of the year. Fortunately the markets came back those next few years and VC funding came alive again.
Back then it was common to say that the hardest part of building a startup was fund raising. Except for a few exceptions, the world of VC was still very opaque to founders. The deal terms were confusing, the tactics employed were coercive, and it was nearly impossible to find the standup investors versus the predators. Founder-friendly was simply not a thing.
The old adage is that when the money runs out, so does your business. This is especially true of startups which do not have access to many of the capital sources that established companies can leverage when the balance sheet goes sideways such as debt financing or private equity buyouts. Money is what keeps the lights on, the bills paid, and the employees happy.
Many startups however do manage to survive for periods of time without funding. Founders often bootstrap the initial stages of building their product before going out to investors. There are times a startup may ramp down spending and layoff staff during lean periods, especially in economic downturns or when pivoting as we saw during COVID. Some even continue to stay afloat even after the cash runs out, something I have experienced before when one startup I was advising had to stop issuing paychecks to employees but managed to survive through that period to become a stronger business.
What allowed these startups to survive and thrive if it was not access to funding? In my recent conversations with startup founders over the past year, there were five very obvious challenges that they faced in building and growing their startups: finding talent, getting customer validation, innovating faster, expanding markets, uncontrolled scaling. Let’s me share more on each:
Finding talent - Everyone is in a talent crunch. For startups without much money and zero recognition, they face an even bigger hill attracting talent. Conversely, out of desperation, some founders make poor hiring decisions which is often worse than having no one at all. In the very early stages, the people you have on your team makes or breaks your startup. That means always looking out for talent, combing your network for potential hires, and ensuring you are hiring people that not only have the right skills, but are aligned on your vision and culture.
Getting customer validation - The only thing that matters for a startup is getting to product market fit. That means finding customers that validate the business model you are attempting to create. The stark reality is that most startups die well before achieving product-market fit. If you build something the market does not value or believe in, you have no customer, no revenue, and no business. All the money in the world will not solve that gap.
Innovating faster - Product innovation is the innate superpower of startups. Without the bureaucratic overhead of a legacy company, startups can build, test, ship, measure, and iterate at faster clips. Yet startups are also constrained by the talent they have available to innovate or by architectural decisions made earlier on for expediency. This baggage weighs in on the delivery of features and the discovery of new insights that slows innovation and impacts customer satisfaction. While rarely the obvious factor of startup failure, it is a slow death behind the more obvious implosion.
Expanding markets - Startups in smaller or more niche markets tend to see faster growth early on. This is because of the familiarity of the market, existing networks, and the power of word of mouth. When the startup needs to expand beyond its known market however, they often run into significant headwinds understanding a new industry, segment, and/or region. The reliable playbook does not carry over, so they try to slog along to figure it out or they hire in the talent to break into that market. Most never build enough traction to make headway, while at the same time they outextend themselves which destabilizes the existing business. While few startups ever fail for this reason, they operate as zombies until acquired or are wound down.
Uncontrolled scaling - This is similar to the challenge of expanding markets, but more to do with premature scaling or being overly aggressive with scaling. When startups scale before they are ready (meaning having customer validation), they accelerate a business model which does not exist. It is like trying to pour gas and lighting a fire on soggy wood. Then there is scaling post product-market fit, but done in such a way where the business is not catching up with costs. This is the “winner takes all” approach advocated by VC’s where business fundamentals come after market domination. We are seeing the problem of this strategy right now as the economy hits a downturn and the VC dollars used to support this strategy dry up. When VC’s can pour on anymore fuel, the party is over and the startup needed to do a massive cost restructuring.
There is also one challenge left unsaid that will become a much more critical going forward. In Amazon, we call these “dogs not barking”, problems we should be aware of. The problem I speak of has upended the web3 / blockchain space with very public and significant hacks and crypto thefts. Security is a heavy lift and with almost all of our data available digitally, the risk of hacks for startups involved in markets that handle lots of sensitive data like in fintech, healthcare, or public sector is very real and potentially catastrophic. When you lose the trust of users, you do not have a viable business anymore.
Fundraising will always be hard. Access to capital has been the lifeblood of startups and has sustained startup ecosystems to experiment and innovate. When you peel back the underlying causes of startup failure however, there is always a deeper root cause beyond the money. If you are mindful of these five key challenges and keep security in mind, your startup might just have a fighting chance.
Mark Birch, Editor & Founder of DEVBIZOPS
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