Why Do Innovative Companies Consume So Much Startup Capital?

The following is adapted from by book More Good Jobs

Imagine walking into a startup meetup and asking the first founder you meet why private capital matters for startups. If they’re like most founders, they will look at you with a blank stare of silent confusion.

Asking a founder why capital matters is like asking a fish why water matters — it’s such an ubiquitous part of their ecosystem that they can’t even imagine a world without it. Startups need capital to get off the ground, and generally, the more innovative the company, the more capital they require.

It’s not hard to see that creating anything unproven in the market is more expensive than copying an existing business model, but what exactly makes startups so expensive?

More than anything, the time, talent, and problem solving that startups require to create or overtake a market makes outside capital a necessary part of the entrepreneurial process.

Problem Solving Costs Money

When you’re solving a problem that no other company has tackled, you’re probably starting from scratch. That means laying the groundwork for your solution, making mistakes, and refining every step of the way — all of which consumes time and money.

Whether the startup is creating a product, service, or technology, there is a lot of problem-solving and customer discovery required to iterate a solution that can scale up to large volume adoption beyond a local marketplace.

Sometimes with a narrow, technology-based innovation that is timed to ride a host of marketplace drivers (e.g., WhatsApp, Instagram, etc.), it is possible for this growth to scale up incredibly quickly. But these are the exceptions, not the norm, as most businesses will go through a series of iterations to tune both the product or service and the path to growing new customers.

Startups Must Educate Customers

Not only do startups need to problem solve, but they also must educate their customers on their innovative solutions. The challenge of educating customers to become early adopters is a big hurdle when you are asking them to stop doing something they are already familiar with.

People are naturally resistant to change, so there’s a burden of proof on the startup to show why the new solution is better in a way that the customer never heard of or thought about before.

Startups also have to convince customers that the risk they’re taking by trying an innovative product won’t backfire. For example, if you opened a hotel, people would instantly understand what you do. But as Airbnb found, even with their Silicon Valley start and backing of legendary startup investor Paul Graham, it proved to be a lengthy process of discovering the right mix of education paths and risk-mitigation mechanisms to drive adoption for allowing strangers to sleep in one’s own home.

For many innovative companies, earning their customers’ trust requires a significant investment of time and money.

Innovation Requires Expensive Talent

Lastly, startups in newer industries consume so much capital because they require expensive talent to solve their problems.

People who already have plenty of other opportunities and sufficient demand for their specialized skills can’t be hired on the cheap, and startups don’t need only one of these workers — they need a whole team.

It’s not realistic to assume that the innovation of a single founder will be enough to cover all the functions encompassed in building a true company that scales up to meaningful levels in headcount and revenue.

This team alone requires a large amount of capital to cover salaries while the startup is gaining momentum and building its revenue stream.

Capital Gives You a Competitive Advantage

With these factors in mind — the problem solving, education, and talent required to succeed — you can imagine how easy it is for an innovative company to consume capital. Most startups simply won’t have sufficient revenue growth soon enough to power through the long product and customer development cycle, so they need significant external capital to get off the ground.

The good news is that in today’s market, you can get a startup up and running faster than ever before. By taking advantage of cloud-based services such as Amazon Web Services or Microsoft Azure, plus prebuilt shopping carts and other online transaction tools, you can build a professional website and start selling your product or service in a single afternoon.

The downside to this is that there’s also more competition than ever before. That’s why one truth about startups will likely never change: capital gives you a competitive advantage.

More money means more talented people creating your solution, more marketing, and more customer education, all of which give your startup the best chance of success.

For more insights on transforming local economies toward job growth in newer industries, you can find More Good Jobs on Amazon. Visit our More Good Jobs Community site to share knowledge and connect with builders and supporters of innovation economies everywhere.  

Scaling up requires working ON the business

When a startup arrives at a stage of product market fit to show steady increases in revenue, my evaluation as an investor expands to include looking for evidence that the leaders are actively engaged in working ON the business itself as the team builds towards scaling up.

Experience helps pick up pattern recognition across a variety of decisions like how to hire winners, manage cash and keep the team on a focused path by everyone working on the right stuff.

But what about first time entrepreneurs, particularly those without prior experience in managing teams?

Founder vision and passion may be there, as well as the persistence needed to stay the course through tough times, but if the business is to scale up – that also means the entrepreneur CEO has to quickly adapt to challenges that each new phase of company growth brings. For rookie CEOs that invariably means navigating through situations he or she has never seen before.

Work Myself Out of A Job

As an active startup investor, I didn’t think enough about this before now. In part due to not having put enough emphasis on how a decade of management experience before starting TriNet was a foundation for my own entrepreneurial journey.

At the outset, perspective about not being the bottleneck for decisions others on the team could make was already part of my mindset. I had seen what worked and didn’t in my prior efforts to empower others so I was tuned to the value of working myself out of a job.

Founders with the startup being their first managerial role are having to learn these basics on the fly, while also carrying the burden of startup pressures on their shoulders as they navigate through unchartered territory every day.

It’s easy to be totally consumed with top of mind priorities like finding new customers and serving existing ones, supporting team members to keep them productive and expanding the team to fill growing demand.

Those and other day to day activities involving immediate people and resource allocation decisions get in the way of putting time into things like refining strategic direction of the company, driving changes in the company’s internal business processes, culture and public identity, finding investment capital as well as developing their own leadership skills for the next stage of company growth.

Working ON the business

Micheal Gerber’s classic “The E-Myth” popularized the notion that if you looked at any truly successful entrepreneur with an enduring company you’ll find someone who committed significant energy to improving the business itself at the same time they were also navigating through significant revenue growth.

Anyone growing a company from scratch knows how consuming the revenue growth and service side can be – so how does one find the time needed to guide improving the business itself?

Scaling up Requires a Capable Management Team

Organizations are only as strong as their weakest links near the top. A high performing team is one that leads together with unifying purpose and consistency in living a company’s core values as everyone puts the overall company ahead of any single individual or department.

But if the early stage team is also new to managing others, as the volume of necessary decisions grow (resource allocation, who to hire, changes to internal processes etc.), decisions which might routinely be made by a manager in a slightly larger organization are instead discussed among the founders to build consensus.

This all happens without much recognition that the time involved to do so inevitably slows down the needed pace of change for the company to adjust to new scale and demands.

There are no rule books out there saying if you are at a certain size this is how decision making should work.

The Founder/CEO sets the tone of evolving who decides what, with the goal of pushing decisions down the hierarchy to the lowest level possible while still having the company be coordinated with the team in sync with each other.

As the business prospers, we’ll all be successful

As soon as we started scaling up at TriNet, our first managers came in at below market salaries but offset with equity upside. There was lots of risk as our industry was unknown and growth prospects uncertain.

It all worked out as that first group of managers came in with leadership experience that made it possible for us to scale up.

Some transitioned out after a few years, several others stayed on for 10 years or longer. And I’m not thinking there was much regret on the part of anyone who took part in the early leadership team as they were all successful in transitioning to other roles where their TriNet experience was valued. Those that exercised stock options and held their shares also reaped significant financial gains downstream.

CEO’s have the opportunity to articulate an inspiring vision for what individual and company success looks like, while at the same time being realistic with regards to expectations. Leaders who are credible in striking this balance attract high performers to the management team who in turn model that behavior as they become critical links for building the company to the next level.

Developing The Company Requires Commitment

Even if the Founder CEO is able to attract experienced managers to the team, the need for management development to work ON the business will be ongoing.

Throughout my TriNet CEO journey I sought out meaningful development opportunities, sometimes as part of industry or entrepreneur conferences but especially where there would be a gathering of peer CEOs who were seeking to learn more about the same issues I was struggling with.

Extra value came from opportunities where those peers then had contact outside the learning session. Building an expanding peer network requires a time investment that also carries the opportunity cost of stepping outside the business to participate.

I could get pretty charged up after hearing wisdom from a world class speaker on some aspect of company development, but then had to be thoughtful about how to bring that new knowledge back into the company.

Our approach included devoting at least one full day per quarter to strategic planning to focus working ON the business with prepared topics addressing known bottlenecks as we generated new approaches to meet higher production and sales growth we were building towards.

In some cases, we enhanced group learning with outside facilitators. We wouldn’t do it often, but as the team grew this proved to be an additional avenue to help get everyone on the same page for important themes we needed to be in sync.

Define and Work the Plan

With so many other things requiring attention in the business, the only way to mark steady progress is to incorporate company development into the operating plan and then track progress against measurable company goals.

We sought out and followed proven structures that helped us learn from what worked well for others. This helped not only on how to frame company development goals but the internal management reporting that cascade down from the overall corporate plan with operating metrics that were meaningful to the people doing the work inside each company department and work unit.

Supplementing written guidance and goals with an outside coach is another way to insure there are eyes on progress against defined management goals that go beyond financial measures and other targets the Board of Directors should be holding the CEO accountable for.

None of this is easy nor will come together with a process that stays rigid. Like most everything in growing a company, the journey begins with commitment to get it done followed by continuous iteration on the approaches used.

With an expanding team, everyone needs to be engaged in contributing to strategic development even while totally consumed with challenges of dealing with rapid growth.

But I’ll argue that unrelenting attention to working ON the business can be the key differentiator separating those who never make it past the startup stage from those who evolve to become true companies.

Prepping the Pitcher

Tips for pitch event organizers and startup founders from an investor’s perspective

Last week I attended a local pitch event for the Upstate tech community that included four entrepreneurs pitching their startups. Like many other such events, the audience was a mixed group of entrepreneurs, community supporters and a small handful of investors. 

The pitches unfolded in typical fashion. When I saw the most common pitch errors across each of the four presenters, I did wonder about how the event organizers went about setting expectations and guiding the entrepreneurs doing the pitching. 

Entrepreneurs know these opportunities are important. They definitely spent time preparing, yet missed the chance to deliver a compelling case. Most importantly, none of the presenters specified what help they were seeking. 

What follows in this post are a few suggestions aimed at both event organizers and pitching entrepreneurs who seek to avoid the boring pitch syndrome.

Tip #1: Problem and solution are not enough

Entrepreneurs (particularly those with a technical background) fall too easily into the trap of using precious minutes in a pitch to dumb down the science. They hope to compel the audience by spelling out the technical challenges that were overcome, and the uniqueness of the startups’ product design.

If half or more of the pitch is spent defining the scope of the startup’s technology, it comes across like an academic exercise. The presenter is seen as working too hard to impress with his or her technical mastery – shortchanging the opportunity to secure support beyond defining problem and solution.

Tip #2: Pitch to investors, even in mixed groups

Even in situations where there is a mixed audience with diverse backgrounds and interests, I’m a fan of crafting pitches as if the entire audience were investors. 

Everyone wins by taking this approach in the pitch because: 

  • A standard set of guidelines can be provided to all presenters that directs them to a specific outcome
  • The event can run on a consistent track, making it easier for the audience to compare pitches with a lens that helps everyone think about how investors look at who to fund
  • The entrepreneur gets an opportunity to further hone the investor pitch, addressing things like business model, channels of distribution, margins and other critical business issues

Tip #3: Close with telling people what you want

I believe it’s essential to end a pitch with a specific appeal for help. Often times someone in the audience can assist the entrepreneur. They just need to ask!

Requests for help shouldn’t be limited to financing. Telling people what else your startup needs right now gets everyone thinking about how and who they know that can assist.

Whether it’s introductions to a specific type of customer or channel partner, or finding new team members, mentors and service providers, pitching is an opportunity to make a personal appeal. Someone in the audience may know the right resource for your company, but only if you tell them what you need.

Tip #4: Event organizers call the shots

With so many startups clamoring for the opportunity to get more exposure, event organizers have the leverage to set high standards for who they choose to present.

Instead of filling slots with whoever raises their hand first, consider inviting entrepreneurs to apply for the opportunity.

Even better, give them a short set of pitch guidelines on what you would like to see included in the pitch, and ask them to send a sample deck for you to evaluate.

It’s ok to tell applicants that their submission is just a sample. Ideally you and members of your supporting team can guide development of the final pitch so that it meets your target standard.

UNY50 - Experienced Entrepreneurs & Investors Provide Pitch HelpIf you need pitch mentoring support, resources like Upstate Venture Connect’s UNY50 Network or investors in any of our local seed funds can help. These same groups can also help recommend qualified startups to pitch.

Setting a high standard for your pitch events, and helping startup founders deliver compelling pitches will not only satisfy your audience, but reflect well on you as a sponsoring organization.

Ecosystem investment helps propel new startup creation

Yesterday morning I had several unsolicited requests for funding from Mohawk Valley entrepreneurs. It seemed odd, since a bunch came in at the same time from the local area.

Then someone pointed out an article in the Utica OD profiling my donor advisory fund at the Herkimer and Oneida County Community Foundation.

While the article wasn’t inaccurate, I can see now that when people think of entrepreneurs helping startups and the word funding is included, than conclusions gravitate towards this being about investment dollars going directly into startups.

It’s true that I’m one of Upstate’s most active startup investors. I’ve touched more than 70 companies through both direct investments and LP relationships in seed and private equity funds. My portfolio and investing interests are profiled on my UpVentures.com site.

But the High Growth Entrepreneur fund at HOC Community Foundation is different. That fund is not about my investing directly in companies, but instead towards supporting infrastructure that helps build our local and regional startup ecosystem.

Startup Ecosystem Infrastructure

For me, startup ecosystem infrastructure includes things like programs, activities, events, online assets and other resources that help bring the right parties together.

Building such infrastructure is my full time volunteer role as I created and help run Upstate Venture Connect, a 501c3 non profit now in our fifth year of operations. (Visit UVC.org to see some of our program initiatives and resources that bring entrepreneurs into contact with others who can help.)

Among the initiatives brewing locally is the thINCubator – a college student startup accelerator program housed at Baggs Square, the Commercialization Academy at AFRL’s Rome Labs and accelerated curation of a startup ecosystem map and events calendar that will bring more visibility to our local startup resources and activities.

Also being worked on is launch of a Mohawk Valley seed capital fund comprised of high net worth individuals qualifying as accredited investors who work together to invest as a group, as well as help mentor and support the startups they come into contact with.

With the Community Foundation donor advisory fund I’m interested in supporting leaders with similar ecosystem building aims – likely to include some new ideas on what could bring the right people together such as experienced entrepreneurs, technical talent, investors, service providers even academics and community leaders. The common denominator is a personal passion for being committed to help startups.

Who knows? Maybe a Startup Weekend, Tech Meetup group, Hackathon, 1 Million Cups chapter or something else not even on our current menu will percolate up.

I’m looking forward to seeing proposals and helping support leaders who are ready to put themselves out there to get something going that helps entrepreneurs and startups.

Whether you’re a startup seeking investment or you see an opportunity to help contribute to building the ecosystem, you can message me through the Babinec.com web site. And consider commenting right on this post below and/or sharing the link with others you know who might have interest.

This is a fun journey with big time impact in helping our best and brightest talent – join us!