When it comes to writing a check for your startup, investors are driven by fear. When they see other investors getting richer, buying stock in your startup may help them reduce their fear of missing out (FOMO). And when the economy is plunging, your startup's need for capital fills investors with fear that they their already severe losses are likely to get worse if they write you a check.
Twenty-six years ago I started my company with the aim of creating my own future -- I was fed up with giving bosses the power to decide my fate. And one thing I know for sure is that as soon as you take other peoples' money to keep your company going, you are giving away that control over your fate.
During an economic expansion, investor's FOMO can give you enough bargaining power -- if your market is growing and you can capture a big enough share of it -- to take other people's money and still control your company's future.
However, the advice that a VC gives you during an expansion can be fatal if the economy abruptly contracts. How so? In good times, VCs push founders to grow their companies as quickly as they can without worrying about making a profit. Simply put, VCs are willing to finance your losses as long as you set your price low enough to grow at least 100 percent a year.
Sadly for founders, that pressure to grow can leave founders with a tiny stake in their company by the time it's sold. An example is Ron Daniel, who now heads Liquidity Capital -- a firm that provides debt capital secured by the company's revenue. As he told me in an April 21 interview, he started a software company, Planet Soho, in 2009 that was sold in 2014. As more investors piled in, he ended up with less than two percent of its equity.
When companies that have raised venture capital find themselves in the midst of an economic collapse, they are forced to abruptly cut costs to keep their companies alive. The reason? Investors that a few months ago were giving their companies more money to grow do a rapid 180 by then telling CEOs that they will not write them another check until they get profitable.
It does not take a genius to realize that taking venture capital can be a terrible decision during an economic downturn. As the Wall Street Journal wrote, trying to get profitable fast means "cutting payroll, slashing marketing budgets to $0, eliminating perks, asking vendors to extend payment terms and scratching for additional capital." As of April 21, 280 startups had laid off 21,609 employees, according to Crunchbase News.
If taking venture capital is a dangerous move, what should you do instead? My recommendation is to follow the prescription in my 2019 book, Scaling Your Startup. I advise companies to scramble to win their first customers, then to stop growing to re-engineer how they operate their business so it earns a profit.
Only after the business proves it can generate more cash as it grows should your business accept funds from venture capitalists.
If you think this can't be done, take a look at Zoom Technologies. I had the pleasure of interviewing CEO Eric Yuan before he took the company public last year and he was one of the few companies to apply this prescription (which Zoom was doing way before I wrote it).
Prior to its April 2019 IPO, Zoom was growing at over 100 percent a year and earning a profit. One key to its profitable growth was doing a better job of meeting customer needs than its competitors did. As a result, customers buy once from Zoom and keep buying more over time.
To me, it's no surprise that Zoom is one of the Covid-19 winners and its stock has soared over 300 percent since its IPO.
The moral of this story is a simple one: To finance your startup while maintaining control over its future is to operate with a business model that generates more cash as you grow. Do that and you won't risk being whipsawed by venture capitalists.