Setting Funds on Fire: How and Why Most Startups Waste Their First Round of Investment

February 12, 2018

2060

Do you remember the first time you were handed $20 by your parents or received your first paycheck from a part-time job while in high school? You most likely don’t, and you probably don’t remember what you spent it on either. I don’t think I’m going out on a limb by assuming that you didn’t put it in a mutual fund or donate part of it to charity. Wise use of money doesn’t always come naturally, but it’s necessary for startup founders.

Before co-founding technology company Zdi, I spent over a decade as an analyst, project manager, and operations director. I was also surrounded by a team and given room to experiment and learn — it was like a financial test lab. Startup founders rarely have the benefit of a strong team, a decade of experience in related fields, and enough room to learn from trial and error, which is why many struggle financially. Founders without financial management skills often see the first round of investment set on fire (not literally).

How It Happens

It’s important to note that no product, service, or highly funded and promising startup is above failing because of financial mistakes. Large, highly respected companies burn through money and make gigantic mistakes just as often as startups do — however, it’s easier for large companies to recover. With a $4.8B pool of debt, Netflix has already spent around $6B on new content in 2017. Will it pay off? Possibly for a company the size of Netflix, but this type of gamble is far less likely to work for a startup.

Here’s an example of how startups often go right through their first round of investment with little to show for it:

Company X has a fantastic idea for a product-based business, and they are interested in fundraising. With a young but solid team to build the first prototype, they are able to convince others that this idea is worth investing in, and they land a few hundred thousand dollars in investment. They now have the money they believe they need to build their product, which they’re sure will be a hit with their future customers. What could go wrong?

The answer is everything — everything can still go wrong. There are several mistakes common among startups that can’t be avoided by throwing additional money at them. No gigantic sum of money can overcome the devastating impact of:

Poor decision-making

You will always make decisions that don’t work out, but understanding and learning from bad decisions is much more important for you and your company than a single good or bad decision.

For example, you may purchase a piece of software or an online subscription that’s either never used again after the first week or is just a bad fit for what you want to accomplish with it. Learning why your decision didn’t work will save your company time and money and keep your team focused on the tasks that matter instead of wasting time trying to implement software that isn’t going to bring value to your startup.

A lack of or faulty planning

Your plan for your company will guide your decisions, for better or for worse. If there is no plan in place, you don’t have a reason to say no to a seemingly good deal or opportunity. For example, let’s say you’ve just been offered a 40% discount on your next $10,000 of advertising with AdWords. While this may be a great deal, if you’ve already exceeded your marketing budget for the month, you should pass. But if you don’t have a marketing plan in place, and you’re making decisions based on instinct or how good a deal is, you’re more than likely to accept a “good deal” and not learn until later that you’re overspending on marketing.

A market that doesn’t want what you’re creating

Amazing ideas and brilliant inventions will still fail if there isn’t a market that is ready to buy what you’re selling. Google Glass and the Segway are just two of millions of examples of products that didn’t have markets ready to adopt them into daily life. If you don’t have a product/market fit, every dollar you spend on advertising, marketing, and sales may be a complete waste. Make sure those you’re targeting with your product or service are compelled and ready to buy from you.

Not being able to find and recruit the right help at the right time

Unless your startup is creating an entirely new market, you are competing against talented and experienced companies for the same customers. To succeed, your startup has to have a high-functioning team with the right employees in place, great mentors, and the ability to find and recruit talent as you grow. A bad hire does more damage to your company than simply waste money — it can slow or stall your growth, while a great hire can speed up your growth and increase your overall chances of success.

If you want to avoid burning through your first round of investment, it will take extensive planning and executing on that plan, along with avoiding the common mistakes and potential roadblocks mentioned above.