Why Do Startups Raise Investment?
This is part one of my nine-part series, exploring every imaginable aspect of startup funding. From funding rounds to valuation methodologies, get ready for a complete crash-course in funding.
Click to read all nine parts as a complete post, or download as a PDF.
From Facebook to Workday, Airbnb to Dropbox, fairytale stories of billion-dollar startups seem to be everywhere. In each instance, there’s a particular fascination on two pieces of information: the company’s staggering valuation, and the investment they secured to get there.
In fact, the link between funding and startup success seems so ubiquitous that many startup founders race headlong into the maw of waiting investors without a second’s hesitation. But to work out the exact relationship between startup fundraising and the phenomenal growth these companies have achieved, we need to dig deep into the world of startup funding.
To get started, we’re answering two crucial questions: why do startups actually raise investment? And is startup funding a prerequisite of success?
THE STARTUP DNA
To answer these questions, we need to dig into the DNA of a startup. Today, the word startup is used to refer to everything from post-IPO tech giants to self-funded artisanal bakeries. In its original use case, the term startup referred to a company with a single defining attribute: it was designed to grow fast.
Many of the characteristics we associate with successful startups (like venture funding, a big exit and the software-as-a-service business model) aren’t prerequisites, but are actually side-effects of this overall pursuit of growth.
To understand how today’s archetypal startup evolved, let’s consider some of the problems that could limit a new company’s growth:
In other words, the defining traits of today’s most successful startups (companies like HubSpot, Facebook and Snapchat) evolved as solutions to the singular problem of growth.
This is why fundraising is part-and-parcel of the trajectory of most successful startups: it provides the resources needed to achieve rapid growth.
FUNDRAISING VS BOOTSTRAPPING
Funded or not, there are a handful of significant costs that all startups will have to pay for, even in the early days:
1) ONGOING PRODUCT DEVELOPMENT
From MVP to polished product, ongoing development is likely to be one of the biggest costs facing your startup.
2) HIRING
Whether you need to recruit a co-founder, first employee or VP Sales, top talent is essential for any successful startup.
3) COGS (COST OF GOODS SOLD)
COGS refers to unavoidable expenses associated with selling and delivering your solution. In SaaS, these are expenses like regulatory and licensing costs, application hosting fees and customer support.
4) PHYSICAL PREMISES
There’s only so long you can work out of your garage.
A self-funded (or bootstrapped) company has little choice but to pay for these costs out of revenue, creating a real-life Catch-22 situation: you need revenue to fund product development, and product development to generate revenue.
It’s still possible to reach the same heady heights as funded companies (Atlassianand Qualtrics were bootstrapped to IPO/near-IPO status), but it’ll be longer before you can make key hires, relocate, or ramp-up your product development, sales and marketing spend.
THE PROBLEM OF COMPETITION
This becomes a real problem when you have rival startups that manage to secure funding. They’ll have access to a ton of capital, and won’t have to make the same compromises as you:
- While you’re hiring a remote developer, they’ll hire ex-Google employees.
- While you’re building out a beta waiting list, they’ll be pulling in revenue.
- While you’re stuck in a basement in the Middle-of-Nowhere, they’ll be networking in the Valley, or the Bay Area.
Straight from the get-go, a funded company has a huge advantage over a bootstrapped company. Even if you’d be happy to take your time, and grow from revenue, you might have your choice taken away from you if a rival company opts for funding.
In a competitive ecosystem, you can bootstrap your startup to success — but it’s likely to be quicker, and safer, to accelerate the process with investment.
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