Money Factor for Sustainable Growth of Tech Startups

by Vlad Grankin

Is the size of the raised financing inversely proportional to talent and effort needed?

“When I started SpaceX, I had nothing but a dream and US$100 million.” Some day Elon Musk will probably say something like this during another interview in a story of miraculous success of changing the world to better. Almost like satirical performance of Mr. Reynholm in “IT Crowd” TV-series:

Certainly, we all know how many ups and downs Elon Musk and his teams had in their quest to disrupt so many traditional industries and really make people’s lives better. The extent of labor, talent, luck, time and faith devoted to bringing up PayPal, SpaceX, Tesla Motors (and more to come) cannot be overestimated. When so many pieces come together in one time period, place and dimension, such great companies arise.

The tales of great leaders, even greater ideas and great results keep entrepreneurs’ (and investors’) hearts on fire in a pursuit to stand in one line with Mark Zuckerberg, Brian Chesky, Travis Kalanick, Elon Musk etc.

However, the other necessary and obvious thing which follows these great successes and stories is money. In 2015 one ordinary article from Business Insider caught my eye. Maya Kosoff and Eugene Kim did not dig deep. They just gave some shallow data on 11 privately owned tech startups valued US$10 billion and more. What drew my attention is how accurate the common “10x Exit Rule” works: roughly all of them raised at least 1/10 of their post-money valuations with Xiaomi as notable exception.

Looking at the same companies now in 2016 we see the same pattern (all in US$, CrunchBase data):

  1. Uber: 62.5 billion versus US$10.61 billion raised to date
  2. Xiaomi: 45B vs. 1.45B (but valuation of this privately-owned Chinese phone-maker is under big question)
  3. AirBnB: 25.5B vs 2.39B
  4. Palantir: 20B vs. 2.42B (however, some of its investors have recently marked down the valuation of the software startup by 32% in their balance sheets)
  5. Didi Kuaidi: 16.5B vs. 4.45B (rumors of raising another 1B with 20B valuation for Chinese on-demand taxi hailing service)
  6. Wework: 16B vs. 1.43B
  7. Snapchat: 16B vs. 1.36B
  8. FlipKart: 15B vs. 3.15B
  9. SpaceX: 12B vs. 1.25B
  10. Pinterest: 11B vs. 1.32B
  11. Dropbox: 10B vs. 1.11B (also recent mark-downs from investors by 50% for once a pearl of Silicon Valley)

What does it all mean?

It is hard to comment on dramatically high funding-to-valuation ratios for China’s Didi and India’s FlipKart. Many experts say that if Didi Kuaidi can really become China’s Uber (with the successful background of Chinese Google — Baidu, Chinese Amazon — Alibaba etc.) and is continuously slapping the global competitor inside its home country, but whether India’s openness can benefit FlipKart to become India’s Amazon is a big question.

In other cases everything remains conventionally simple: to build a $1 billion valued startup you will need to raise around 100M. If you are really good in what you do you might need 50M or less. If you are not so good, you might need 200M.

This does not cross out the need for above mentioned exceptional talent, luck and labor to build a truly unique and disrupting company.

However, the other logical question may be more interesting: do you need less talent and effort to reach the same great results provided you have better funding? Or even more interestingly: is the size of the raised financing inversely proportional to talent and effort needed?

The answer seems obvious. Let’s imagine two competitors in the same market with different funding. If both of them reached equal performance, the one with lesser financing will be considered better.

So how to become better and not over-dilute your shares

  • Keep CAC constantly higher than your LTV.
  • Be sure that on every iteration your MVP is the real MVP necessary to do all the tests and checks. Don’t over invest in something you will completely change and pivot soon. Follow the path of Voice of Customer on evolutionary basis as the customer behavior changes.
  • Keep your burn rates as low as possible at all times. Have the culture of costs-to-incomes accountability for each employee.
  • Don’t start pricing wars. Win your customer thanks to quality and better service.
  • Don’t hire lots of new staff. Be innovative and efficient. You are a tech startup after all, aren’t you?
  • Do what you are best at and don’t spread your focus thin over too many things.
  • Make sure you pay your best talents well. They bring 80% of your revenue and value.
  • Value and praise your loyal customers and employees. They will save you during harsh times.
  • Don’t over invest in trendy marketing things until you are sure you can be good at it and the ROI is OK. E.g., if your team is unable to deliver great engaging content, stop harassing them and spending on editorial. Let your team do what they are best at.

So money matters. But for those of great mind they matter less. Much less.

This controversial pursuit of finding the right balance for entrepreneurs follows my previous thoughts on the same topic for venture capitalists’ challenges in 2016.