The Venture Capital Burn Rate Trap and How to Avoid It
Here’s an evolution of the venture capital playbook that tends to hit entrepreneurs in the guts:
Investors give your startup a lot of money to scale, they expect you to hire experienced people for critical roles, and then they start asking why your burn rate is so high.
The next thing that happens is a strongly implied “cut the fat” suggestion. Then things darken as you learn how to cut people off without killing both productivity and morale, which, spoiler alert, you can’t.
Then all the charts from top to bottom go from bottom to top right for a little while. Then the investors ask what happened to all that money they gave you.
I have seen this happen time and time again, and I myself have been caught in this trap. I’ve learned that this is all pretty much the startup’s fault, and I’ll explain why.
Investors want lean teams.
Venture capitalists love lean teams the same way little kids love birthdays and cakes, so they go crazy for the birthday cake.
In other words, investors like lean teams because of the combined economies of scale:
If two people each generate X income, then by working together as a team, they will generate more than twice as much income.
If that team can make a profit at cost X, then a lean team will make more profit by finding ways to reduce that cost.
Then crazy projections are made and money is thrown into them.
This is where the trap kicks in, because economies of scale work on a curve, not on a spike, and they always produce friction before producing results.
Here are four ways the startup sets its own growth trap.
1. The startup is hiring too quickly.
There is an old conventional wisdom around startups and money that boils down to “If you can get the money, take it.”
You see this a lot with fundraising. If a startup is able to raise funds, it should because the fundraising window can close quickly and without warning.
Once that new money reaches the startup’s bank, the same logic applies, but now switches from incoming money to outgoing money. In other words, “If you have the money, spend it.” Thus, the startup embarks on a wave of hiring, rapidly expanding the team in order to increase productivity exponentially.
But each new resource takes time to become productive. When you hire one resource at a time, the startup can absorb the productivity blow. When you hire five or 10 or more at a time, it can take months or even years for the startup to take advantage of the results multiplier.
To slow down. Hire one resource, then focus on making that resource productive before hiring the next.
2. The startup exceeds skills and experience.
When you’re a rambling startup that suddenly has corporate money, the temptation is to hire these experienced corporate resources, especially if you can poach them from one or more of the incumbents your startup is trying to disrupt.
But while these experienced resources may be exceptional in their current role, it rarely translates into a return to their old startup role. They often bring with them all the baggage that turned their old business into the incumbent operator you’re now trying to disrupt, and they rarely want to let that baggage go.
3. The startup hires people who are neither manufacturers nor sellers.
There is certainly a time to hire resources that can focus on the organization itself, but in the beginning — say, the first two or three big fundraisers — those resources are still a luxury.
It kills me when I see the CEO of a 10-20-person startup with an execution rate of less than $ 10 million hire an executive assistant. Or a whole new three-person human resources team to grow the startup from 10 to 100 people in a few months.
If you need to hire for these internally focused roles, work with them to strategically redefine that role to create a better product or sell more of it.
4. The startup hires people who don’t work well together.
Maintaining a healthy corporate culture is essential for a startup. This culture still tends to disintegrate around fifty employees, sometimes earlier.
The worst thing the startup can do here is start drawing lines around their employees and teams based on who works best with whom, but that’s usually what happens.
The root of the cultural problem is that when you hire 50 employees, you hire 50 different ways to get things done. If founders don’t take the time to define, document, and communicate their own methods and strategies before embarking on a hiring wave, then they’re leaving it up to their employees to sort through the chaos.
The lesson of the venture capital growth trap is that you can’t skip your way to productivity. Of course, new money buys you resources, but it also saves you time. Use this time to grow productively.