The Scary Secret VC-Backed Founders Don’t Want You To Know

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The Scary Secret VC-Backed Founders Don’t Want You To Know

The scarier part is what they’re planning to do about it.

The Scary Secret VC-Backed Founders Don’t Want You To Know
Photo by DESIGNECOLOGIST on Unsplash

My friend recently started a killer gig at a VC-funded startup. The money was good, the equity and upside potential great, but a lingering fear crept into his mind and wouldn’t leave.

They’d just closed a $40M round and have been hiring like crazy, building out a top-notch IPO team so they’d be prepared for their big public market debut in the next two years. Point being, all signs hinted that this startup (a B2B tech company catering to a historically stable industry) was destined for success — and its equity-holding employees wouldn’t want to pass that up.

Then, within five months of starting the job, my friend came to me, wrestling with the temptation to leave. The culture was pretty bad and the hours worse, but those were factors I — and he — could overlook for the right price. That price, however, and the company’s fate and survival skills altogether, were the red flags that sent my friend packing, in an awkward unplanned resignation before jumping onto yet another possibly sinking ship.

If you’re a founder, this affects you. If you work for a venture capital-backed company (or any business), this affects you. If you’re thinking about starting, buying, or running a business, this affects you.

Here’s the under-the-table strategy that’s been capturing VC money, draining funds, and leaving employees scared (or jobless), founders rattled, and investors angry. Oh, and here’s what you can do to spot, solve, and avoid it.

You couldn’t possibly raise money off just your looks, right? Well, when “looks” refers to the deep bench of expertise portrayed by your founding team, then perhaps you could. In my friend’s case, that’s exactly what happened: The founding team was comprised of flashy credentials and impressive track records, thus winning over investors’ hearts before talking numbers.

That might sound shocking or rare, but they’re far from the only startup that’s raised money without proving out a profitable customer acquisition strategy. In fact, there’s another startup that raised money around a very expensive sleep-related product, solely because it’s a more eco-friendly option. With a few of the right buzzwords and key players, they, too, were off to the races.

In both cases — and that of countless other startups I could swap in — they decided to deploy their capital to product development first. “Company A” hired all the tech, then subsequently began courting half of their marketplace (they’re a tech marketplace that connects two parties). “Company B” went all-in on R&D, spending millions just to arrive at a tolerable version of their product and subsequently flooding the world with awareness ads.

Company B recently hired a financial team to check up on “how they’re doing”, and my friend just happened to be on that team, with an up-close glimpse into where they’ve gone wrong — and it’s actually terrifying.

Company A (the tech marketplace): Have they been growing? Yes, but that isn’t the whole story. In order to achieve the aggressive growth they (and their investors) want to see, they’ve hurled the biggest chunk of their limited and quickly dwindling capital at salespeople: Cold-calling salaried and commissioned salespeople. Is it working? If you look at the attrition and the startup’s declining pile of funds, I think not…

Company B (green sleep): These guys have been expanding like crazy, between hiring, digital marketing, and multiplying their brick-and-mortar presence with countless new retail shops. However, they seem to have forgotten a cardinal rule: Growing expenses should result in growing sales and ideally a positive return on that investment; if you grow too fast, you may forget to check that ROI.

Once headcount was slashed at Company A and the word “going concern” was uttered at Company B, it became clear to my friend that both startups were suffering a similar ailment, and they didn’t even know it.

I shouldn’t have to ask my friend to check on a company’s remaining cash reserves and profitability (or lack thereof) to identify a major financial problem. Nonetheless, that’s exactly what happened.

The scariest part isn’t that investors were willing to dole out millions without proven product-market fit or any realistic estimate of CAC or customer LTV. That’s concerning, but not quite as scary as the fact that these startups aren’t realizing the problem until now, when the VC rounds have dried up.

When they’re asking outside consultants whether their company will still be a “going concern” in 6 months? Red flag. When they’re trying to figure out how they’ll stretch $20M through a prospective 2-year upcoming recession while saddled with a $3M/month burn rate and no profitability? Alarms go off.

In a word, everybody who’s raised funding without a proven profitable customer acquisition strategy or a healthy enough pile of cash to ride out the dry spells until they determine how to achieve that profitable CAC.

No industry is immune from money mismanagement or poorly ordered priorities (like sinking all your capital into your product, team, or tech, at the expense of probing what customer acquisition really takes and looks like).

This isn’t a “tech” thing or a “real estate” thing or a “luxury products that aren’t recession-resistant” thing. This is an entrepreneurship thing, and it’s one exacerbated by fast, cheap, easy money that’s flown into flashy-looking teams with buzzwords, trending industries, and impressive credentials.

Simply put, if these companies can’t show material progress or obtain a profitable CAC, they won’t be able to raise more funding. If they can’t raise more funding, they shrivel up and die (or slash headcount and find shoestring budget solutions until they solve the real problem).

First off, if you’re running a startup and you think the answer is raising venture capital, I’d urge you to pause and reassess. Do you really, absolutely need that funding — and do you need it now?

I don’t say that to imply that VC is bad or doesn’t have its place. I say that because founders have been using it as a Band-Aid for much larger and pervasive problems they have yet to solve. Venture capital is not meant to be a crutch for your inability to profitably acquire customers; it’s meant as rocket-fuel to get you what and who you need to start acquiring them.

Furthermore, the pay-to-play strategy is far from a blanket solution to throw all your funds at the wall and pray some stick and result in a profitable return. Pay-to-play works until you run out of money, and if you haven’t mastered a profitable method of customer acquisition, it’s only a matter of time before your capital dwindles perilously close to zero.

How can you avoid this terrifying race to the bottom? A few quick tips:

  • Know your burn rate
  • Monitor your profitability or growth
  • Analyze every single marketing channel and campaign
  • Make happy customers and a profitable customer acquisition strategy your two top priorities. Not new products. Not impressive hires. Not wasting your time on the fundraising rollercoaster. If you conquer these two feats, your cash reserves won’t dwindle, and investors will be your thirsty suitors to reject, not the other way around.

I had a close family friend who would always justify big, not-so-practical purchases with the saying “it’s only monopoly money”. That might make some people feel better, but in business, startups, and particularly money taken from legitimate investors who expect a return, it simply isn’t true.

If more founders looked at VC money as if it were their own limited pool, they might accept that sometimes there isn’t another round. Sometimes the well does dry up, and you’re left on your own to replenish it or otherwise save the day.

Venture capital money isn’t your grandpa’s millions for your passion project. It’s the dry powder with which a discerning investor has entrusted you in the good faith that you’ll use it wisely, strategically, and thoughtfully, for your mutual benefit. Use it well.

Go to Publisher:

Entrepreneur's Handbook – Medium


Author: Rachel Greenberg