Diary of a Social Venture Start-up: Why Staging Works
You hear a lot about slow these days. Slow design, slow food—GOOD even did a whole issue on the concept recently. I'm going to argue for a kind of slow you might not expect from an entrepreneur: Slow funding. When you talk to business folks about starting up, you often hear the same thing: Raise as much money as you can up front. At first, this seems like very solid advice. Doing so allows you to have a war chest for when things don't go as planned. However, there's a downside to this approach that too few entrepreneurs consider, namely, the cost of cash.
Let's say your company is in the early stages. You've got a good idea, demonstrated some results, and you're looking to scale up. To do so, it'll take $2 million. Presumably, by this point, your company has some value. If someone's going to give you the cash, they'll be taking a chunk of your company in the form of equity. The more your venture’s worth, the less they'll need. Trouble is, when you're starting out, you're not worth all that much.
So, let's recap: you're not worth much, you haven't proven much, and you need someone to take a chance on you and cut you a big, fat check. Intimidating, huh? This is why most investments (especially those from VCs) are staged. If you haven't heard the term before, it basically just means that you don't get all of your needed funds up front. Traditionally, you raise one round (called a Series A) in order to demonstrate progress, after which you raise subsequent rounds (Series B, C, and so on). Each gives you enough cash to grow, to demonstrate value, and to convince people that you're worth continued investment.
As much as this seems like a way for VCs to protect themselves (which it is), it can also be to your benefit. If you've raised your Series A and done well with it, it's likely your venture is worth more than it was before. As a result, you can raise money more cheaply. So, as opposed to raising all of your needed funds up front for some percentage of the company, you'll be able to gradually raise that same amount of money while giving away substantially less.
The other good thing about staging is that it keeps you hustling. If you’re suddenly blessed with a fortune, it’s hard to stay focused on your goals. Take Boo.com, for example, who quickly raised $135 million and was out of business in 18 months. While much of this had to do with the business model (internet speeds had not yet evolved enough to handle their technology), the company did everything they could to burn through capital. One London Telegraph article went so far as to say, “for the first nine months of its existence, the company was run on the economic rule of the three Cs – champagne, caviar, and Concorde.” If you’re interested, there’s a good book about Boo’s rise and spectacular fall.
Staged funding implements the carrot and the stick. You’ve got to work for your money, which seems fair to me. It should be noted, however, that while this provides continued motivation, it’s also an inherent danger. If a VC is overly strict about relying on performance milestones to determine future funding, it can be hugely detrimental to a business. You're going to have a hard time innovating and evolving if you're too focused on hitting some particular number. Moreover, one might argue that such a situation incents the entrepreneur to window-dress or cook the books (because if he doesn’t hit his numbers, he thinks he’ll lose his funding). Clearly, that’s not beneficial for anyone.
The good news is, many VCs will work with entrepreneurs to ensure that the company is headed in the right direction, whether or not that involves the original plan of attack. In many cases, VCs are your best friend. That is, until they’re not. It’s all part of a complicated relationship I’ll delve into next time.
The Takeaway: With any start-up, it’s difficult to get someone to hand you all the cash you need up front. Even if you can, the staging method has definite advantages. It’ll keep you motivated and, more importantly, by proving success incrementally, you’ll be able to raise money without unnecessarily over-diluting your ownership.