The Silicon Valley culture is renown for producing blistering hot waves of start-ups. Some go on to be real world-changers. Right now the climate is cooking and the air is filled with excitement and a unique aroma - the smell of investors dollars being burned at record rates. Should entrepreneurs and VC's be worried? You bet.
Its frothy as a cappuccino out west and as we have come to expect, bubble anxiety looms large. Concerns were amplified recently when a couple of highly respected VCs wrote terse warnings that burn rates have climbed to historic highs as startups find easy capital and pursue aggressive (some say reckless) land-grab strategies. The big concern being that the easy-cash party will end at some point and when the music stops, companies burning lots of cash yet short on reserves will be SOL. This has sent company boards everywhere scurrying to scrutinize expense rates.
Yet the number of $1B-plus liquidity events is at record highs. 2014 is on track to produce a record 20 jumbo tech IPO's in the $Billion-plus club. How? Companies are putting capital to work to establish their brands, build market-share and achieve critical mass. And they are doing it faster by leveraging the efficiencies of the Internet and mobile technology.
Investing to build out a defensible position is a legitimate strategy supported by the growing number of growth venture funds who are more than happy to write big checks at high valuations. So while some VCs are expressing caution about burn, others are cheerleaders, waving tens of millions of dollars like so many pom-poms. How should a responsible entrepreneur deal with these conflicting signals?
First and most importantly, burn should keep you awake at night. Capital fuels hyper-growth so cash burn is a normal part of growing businesses. But it is also a dependency that demands a constant fresh supply. If that supply becomes constrained your company can be in great peril, and it might happen in a flash because investors can be very fickle.
Five years ago, social media was a blistering hot investment category. Today? not so much. During that same time period there was very little interest in enterprise software, currently an en-vogue darling. If VCs get spooked about your category the throngs who were pounding on your door dying to get money in will be nowhere to be found. There is good reason to toss and turn at night yet so many entrepreneurs are falling asleep with dreams of joining the coveted billion-dollar valuation club.
This is the best time to raise money. The old saying goes, best time to raise dough is when you don't need it and young, growth-stage companies are taking this saying to heart. A typical C round can be upwards of $50m, roughly equivalent to the median proceeds of an IPO during the dotcom bubble! Plus there is tons of competition amongst VCs to get into the most promising companies and it drives valuations very high. So the money is coming with very low dilution. How yummy.
Entrepreneurs are routinely counseled by their existing investors to take the money while they can and fill up the coffers for a rainy day. This is sound advice except for one flaw. Spare cash is never spared. A big cash balance has a way of corrupting corporate cultures. Fancy furniture, expensive office space, Michelin-quality food service, business class airline seats, excessive off-sites, and lavish parties all of a sudden become "necessities" to attract talent and maintain morale. But make no mistake; it's the high cholesterol of start-ups, a heart attack and stroke lurking in the shadows.
We all know your company is very special and you want to grow it as quickly as possible so you can change the world. And if you find the backers you should go stake your claim. But keep in mind that you're not so special that the laws of business physics don't apply. So while you are shoveling bales of cash into the expansion bonfire, here are a few pointers to keep you from being burned.
- Hire with care. Good talent is very hard to find these days and many companies feel they need to "inventory" great people when they are available. But keep in mind that personnel is your largest expense and when you hire someone you make a moral commitment to run your company well and keep them employed. Presiding over layoffs really sucks.
- Young companies consistently underestimate the time and difficulty of accurately projecting and meeting revenues. Do not ramp expanse rates too far ahead of revenue. This issue is a common cause of start-up mortality
- Run lean. As much as employees like all of the goodies, they also respect responsible management. Watch the pennies and run a tight ship.
- Maintain a healthy cash reserve. Different people will tell you different numbers but in the volatile world of the tech sector you should maintain a minimum of 12 months of cash reserve. If you are burning $1m a month that means $12m. Sounds like a lot but in a downturn it can keep you alive or save you from a punishing down round.
- Always have a contingency plan. If you had to cut your expenses by 50% to survive how would you do it? Don't just think about it - model it. Keep it in a special drawer, update it regularly but hope to never have to use it.
In an environment where investors cherish and pay high valuations for companies with dramatic growth potential and entrepreneurs covet a fast rise to the Billion Dollar Club, it's easy to get lulled into a false sense that the elevator always goes up. The next correction inevitable -- it's not if, but when. Seizing an opportunity is a critical part of entrepreneurial success but overheating your business is akin to playing with matches. Only you can prevent yourself from being forced to watch your dreams vaporized by uncontrolled burn.