Start-ups, unlike standard businesses often have to grow fast and try to conquer the market before any other competitor does it!
In their pursuit of market conquest, these mostly high tech businesses often forget the basic rules for running a company and growing, they forget that they should focus on revenue, instead they try to grow quickly hopefully to get acquired by big tech companies. This behavior requires lots of cash and consumes lots of money quickly, and in the last few years this trend have seen a bigger following. Investors and Venture capitalists are sounding the alarm, on this greed mentality, and recently some big investors have decided to talk about this issue.
In his book Zero to One, Peter Thiel, Paypal founder and investor in many other companies, addressed the issue that preceded the 90’s tech bubble saying:
the most “successful” companies seemed to embrace a sort of anti-business model … where they lost money as they grew.
This is exactly what is happening our days, startups are growing fast fueled by the investors money, to give you some examples take, Uber, Twitter … these companies are multi-billion in value and yet they are not profitable and never were! Hundreds of others startups are way overvalued, valued on their growth which is basically fueled by the investors money, and most of them are not making any money!
Top Venture Capitalist Marc Andreessen sounded the Alarm recently in a a series of 18 tweets saying
New founders in last 10 years have ONLY been in environment where money is always easy to raise at higher valuations. THAT WILL NOT LAST.
When the market turns, and it will turn, we will find out who has been swimming without trunks on: many high burn rate co’s will VAPORIZE.
High cash burn rates are dangerous in several ways beyond the obvious increased risk of running out of cash. Important to understand why:
Then proceeding to explain the 8 points tech startups should understand:
- High burn rate kills your ability to adapt as you learn & as market changes. Co becomes unwieldy, too big to easily change course.
- Hiring people is easy; layoffs are devastating. Hiring for startups is effectively one way street. Again, can’t change once stuck.
- Your managers get trained and incented ONLY to hire, as answer to every question. Company bloats & becomes badly run at same time.
- Lots of people, big shiny office, high expense base = Fake “we’ve made it!” feeling. Removes pressure to deliver real results.
- More people multiplies communication overhead exponentially, slows everything down. Company bogs down, becomes bad place to work.
- Raising new money becomes harder & harder. You have bigger bulldog to feed, need more and more $ at higher and higher valuations. / Therefore you take on escalating risk of a catastrophic down round. High-cash-burn startups almost never survive down rounds. VAPORIZE. /Further, to get into this position, you probably had to raise too much $ at too high valuation before; escalates down round risk further.
- Even if you CAN raise an up round, you are increasingly likely to incur terrible structural terms like ratchets to chin the bar. That nice hedge fund investor willing to hit your valuation bar? Imagine him owning 80% of co after down round. How nice will he be then?
- When market turns, M&A mostly stops. Nobody will want to buy your cash-incinerating startup. There will be no Plan B. VAPORIZE. Finally, there are exceptions to all this. But if you’re reading this, you’re almost certainly not one. They are few and far between.
Marc Andreessen, was not the first to sound the alarm, but having top VC like Marc weighing in such a way on this subject means that things are bad, as you can see the tweets below Andreessen started by agreeing with other VC and ended his tweets by a worry!
— Marc Andreessen (@pmarca) September 25, 2014