Fundraising Is a Means, Not an End

For many entrepreneurs “raising money” has replaced “building a sustainable business” as their goal. That’s a big mistake. When you take money from investors their business model becomes yours.

One of my ex students came out to the ranch to give me an update on his startup. When I asked, “What are you working on?” the first words out of his mouth was his fund raising progress. Sigh… What I should have been hearing is the search for the business model, specifically the progress on product/market fit, but I hear the fund raising story first at least 90 percent of the time. It never makes me happy.

Entrepreneurs need to think about 1) when to raise money, 2) why to raise money and 3) who to take money from, 4) the consequences of raising money.

It all starts with understanding what a startup is.

What’s a Startup? Just as a reminder, a startup is a temporary organization designed to search for a repeatable and scalable business model. It’s worth parsing this sentence:

• Temporary Organization: The goal of a startup is not to remain a startup. The goal is to scale. (If you don’t have scale as a goal then you shouldn’t be raising money from angel or venture investors, you should be getting a commercial or government small business loan.)

• Search. Although you believe your idea is the most brilliant innovation ever thought of, the odds are that you are wrong. If you raise millions of dollars on day one, simply executing the idea means you’re going to waste all those dollars attempting to scale a bad idea.

• Repeatable: Startups may get orders that come from board members’ customer relationships or heroic, single-shot efforts of the CEO. These are great, but they are not repeatable by a sales organization. What you are searching for is not the one-off revenue hits but rather a repeatable pattern that can be replicated by a sales organization selling off a pricelist or by customers coming to your web site.

• Scalable: The goal is not to get one customer but many – and to get those customers so each additional customer adds incremental revenue and profit. The test is: If you add one more sales person or spend more marketing dollars, does your sales revenue go up by more than your expenses?

• Business model: A business model answers the basic questions about your entire business: Who are the customers? What problems do they want solved? Does our product or service solve a customer problem (product-market fit)? How do we attract, keep and grow customers? What are revenue strategy and pricing tactics? Who are the partners? What are the resources and activities needed to make this business happen? And what are its costs?

Who to Take Money From?

First, decide what type of startup you are. If you’re a lifestyle entrepreneur or a small business, odds are the return you can provide is not what traditional angel or venture investors are looking for. These types of startups are better suited to raising money from friends, family, commercial and government small business loans, etc.

If you’re a scalable startup, you want to spend small amounts of money (seed capital) as you run experiments testing your hypotheses. Why small amounts? No startup ever spends less then it raises. And at this early stage you’ll be giving up a larger percentage of your firm to investors. A seed round can come from friends, family, Kickstarter, angels – and most importantly, early customers.

These sources are a lot more forgiving of iterations and pivots than later-stage venture-capital funds.

When to Raise Money

In a Lean Startup, the goal is to preserve your cash until you find a repeatable and scalable business model. In times of unlimited cash (internet bubbles, frothy venture climates) you can fix your mistakes by burning more dollars. In normal times, when there aren’t dollars to undo mistakes, you use Customer Development to find product-market fit. It’s only after you have found product-market fit (value proposition – customer segment in the language of the business model canvas) that you spend like there is no tomorrow.

Don’t confuse “raising money” with “building a sustainable business.” In a perfect world, you would never need investors and would fund the company from customer revenue. But to achieve scale, startups need risk capital.

Raise as much money as you can after you have tangible evidence you have product/market fit, not before.

The Consequences of Raising Venture Money

The day you raise money from a venture investor, you’ve also just agreed to their business model.

Here’s a simple test: If you’re the founder of a startup, go to a whiteboard and diagram how a VC fund works. How do the fund and the partners make money? What is an IRR? How long is a fund’s life? How much will they invest in the life of your company? How much do they need to own at a liquidity event? What’s a win for them? Why?

There are two reasons to take venture money. The first is to scale like there is no tomorrow. You invest the dollars to create end-user demand and drive those customers into your sales channel.

The second is the experience, pattern recognition and contacts that great investors bring to the table.

Just make sure it’s the right time.

Lessons Learned

  • Fund raising is a means not an end
  • Preserve your cash until you find a repeatable and scalable business model
    • Focus on product – market fit
    • Run small experiments testing your hypotheses
  • Raise as much money as you can after you have tangible evidence you have product/market fit.

Author: Steve Blank

A prolific educator, thought leader and writer on Customer Development for Startups, Steve Blank is a retired serial entrepreneur who teaches, refines, writes and blogs on “Customer Development,” a rigorous methodology he developed to bring the “scientific method” to the typically chaotic, seemingly disorganized startup process. Now teaching entrepreneurship at three major universities, Blank co-founded his first of eight startups after several years repairing fighter plane electronics in Thailand during the Vietnam War, followed by several years of defense electronics work for U.S. intelligence agencies in “undisclosed locations.” Four Steps to the Epiphany, Blank’s fast-selling book, details the Customer Development process and is increasingly a “must read” among entrepreneurs, investors, and established companies alike, when the focus is optimizing a startup’s chances for scalability and success. After 21 years driving 8 high technology startups, today Steve teaches entrepreneurship to both undergraduate and graduate students at U.C. Berkeley’s Haas School of Business, Stanford University’s School of Engineering and the Columbia/Berkeley Joint Executive MBA program. His “Customer Development” teaching and writing coalesce and codify his experiences and observations of entrepreneurs in action, including his own and those he advises. “Once removed from the day-to-day intensity of founding a startup, I was able to observe a pattern that distinguishes successful startups from failures,” Blank says. In 2009, he earned the Stanford University Undergraduate Teaching Award in Management Science and Engineering. The San Jose Mercury News listed him as one of the 10 Influencers in Silicon Valley. In 2010, he was earned the Earl F. Cheit Outstanding Teaching Award at U.C. Berkeley Haas School of Business. Despite these accolades, Steve says he might well have been voted “least likely to succeed” in his New York City high school class. Steve Blank arrived in Silicon Valley in 1978, as boom times began. His early startups include two semiconductor companies, Zilog and MIPS Computers; Convergent Technologies; a consulting stint for Pixar; a supercomputer firm, Ardent; peripheral supplier, SuperMac; a military intelligence systems supplier, ESL; Rocket Science Games. Steve co-founded startup number eight, E.piphany, in his living room in 1996. In sum: two significant implosions, one massive “dot-com bubble” home run, several “base hits,” and immense learning leading to The Four Steps. An avid reader in history, technology, and entrepreneurship who seldom cracks a novel, Steve has followed his curiosity about why entrepreneurship blossomed in Silicon Valley while stillborn elsewhere. It has made him an unofficial expert and frequent speaker on “The Secret History of Silicon Valley.” Steve’s interest in combining conservation with best business practices had Governor Arnold Schwarzenegger appoint him a Commissioner of the California Coastal Commission, the public body which regulates land use and public access on the California coast. He also serves on the Expert Advisory Panel for the California Ocean Protection Council. Steve serves on the board of Audubon California, was its past chair, and spent several years on the Audubon National Board. A board member of Peninsula Open Space Land Trust (POST), Blank recently became a trustee of U.C. Santa Cruz and a Director of the California League of Conservation Voters (CLCV). Steve’s proudest startups are daughters Katie and Sara, co-developed with wife Alison Elliott. The Blanks live in Silicon Valley.