Capital Before Customers: The Misstep Many Founders Regret ~via David Baker
I connected with David Baker just over a year ago, and then had the good fortune of meeting him f2f when John Andrews and I road-tripped through Fayetteville shortly thereafter in December of last year. Since then David has impacted me in many ways... personally and professionally. Mostly in the way he looks at start-ups and entrepreneurship. This post is a good introduction to David and his perspective. /Ted
Setting the Stage
In the vibrant world of startups, the allure of early-stage investment is palpable. On the surface, it's grounded in sound logic: de-risking one's salary, acquiring resources to build a product, or even creating something that can be sold — all of these motivations can make raising capital seem like a prudent move early on. However, when juxtaposed against the stark reality of startup success rates, this allure begins to wane. The perceived safety net of early investment can, in fact, introduce unforeseen challenges and, more often than not, does not lead to success.
*Note: This article is not a diatribe against the merits of venture or angel capital. Instead, it is an exploration into the unseen risks of taking on debt before genuinely validating a business's potential.
Two Guys Walk Into a Coffee Shop
Last week, I had the privilege of engaging in a fantastic conversation with Mark Zweig, a renowned founder, investor, innovator, and teacher. Mark's reputation precedes him, and his opinions are borne of life experience. Our discussion, while wide-ranging, centered on a core topic: the foundational principles behind a successful business versus the prevailing hype in the startup culture. We both agree that, of these principles, revenue generation stands alone as the key metric and litmus test for a business' viability.
Why Revenue Validation is Non-Negotiable
Revenue validation is not just another box to tick; it's the bedrock of your business's legitimacy. It's tangible proof that there's a genuine demand for your offering. Seth Godin, the marketing maestro, has consistently championed the value of real-world validation.
"Start your first business this way: Begin with the smallest possible project in which someone will pay you money to solve a problem they know they have. Charge less than it's worth and more than it costs you. Repeat. You don't have to wait for perfect or large or revered or amazing. You can start." — Seth Godin
His advice to founders is crystal clear: in the beginning pitch to buyers, not investors. After all, it's the buyers who validate your business with their hard-earned money, not just with encouraging words.
Debunking the 'Unmonetizable' Concept
The most common refrain among founders when faced with this advice is the belief that their concept is too novel, too groundbreaking or too complex to be monetized in its nascent stages. While there are always outliers, the reality is that most startups can, and should, find avenues to generate early revenue. It's not just about the money - in fact it's more about what it signifies. This initial trickle of income not only substantiates the business model but also diminishes the over-reliance on external funds. Above all, it's the only way to get true feedback. Paying customers don't pull punches, and you need to get hit with reality so you can understand what THEY need instead of what you think they need.
The Hidden Burden of Raising Capital
Securing early-stage investment is not just about acquiring funds; it's an intricate dance that demands huge amounts of time, energy, and a shift in focus. The capital-seeking founder must make early determinations about existing assumptions in order to build a business plan and financial forecast that will garner attention, and secure funding. In addition, this process often necessitates making new assumptions about future growth, market dynamics, and customer behavior or pricing strategies. All of these determinations, while necessary for pitching to investors, introduce even more work to be done post-raise.
At a stage where founders are already navigating the uncharted waters of their business, these added pressures increase the set of constraints placed on a founder by forcing them to commit to, and sell, confidence in a hypothetical path to success. Anything that diverts a founder's attention away from immediate, tangible challenges is logically counterproductive.
And so, the very act of raising capital, while providing financial relief, can paradoxically increase the operational and strategic burdens on a startup.
The Constraints of Premature Debt
Venturing into the capital-raising arena without revenue validation can be (and often is) fraught with constraints that discourage founders from some of the most important behaviors associated with successful ventures, such as:
Misaligned Priorities: The looming pressure to deliver returns can inadvertently skew a founder's focus, placing investor interests above those of the customer.
Diminished Agility: A hefty capital influx often brings with it an urgency to scale, sometimes sidelining organic growth and the flexibility to pivot when necessary.
The Weight of Expectations: Every dollar raised amplifies the expectations. Meeting these, in the absence of revenue validation, becomes a Herculean task.
I will share that in the last few months I've spoken with several startup founders (some of whom have taken on hundreds of thousands in capital) that are struggling with this exact situation. Their intentions (and those of the investors) were all good. But good intentions do not ameliorate the very real and unavoidable challenges that come with raising too early.
It's a frustrating and negative experience that, unfortunately, can sour a budding entrepreneur from even making another attempt at building a venture. There are some who can pull out of the nose dive, but many succumb, unable to find fit.
A Beacon for Founders in Choppy Waters
For those founders who've already embarked on the investment journey without some kind of revenue validation, it is not hopeless. In fact, recognizing the dynamics at play and their influence on decision-making is half the battle.
If you're in this situation, watching your runway shrink, consider the following lifelines that can help reset the situation:
Trim the Fat: Scrutinize every expense. This might mean the founder supplementing the startup's income with a part-time job or even taking a strategic pause to reassess the business's trajectory.
Revert to the Fundamentals: Refocus on revenue validation and leverage sources of momentum that are free - call in favors. Engage directly with customers, refine your MVP, and prioritize tangible sales above all.
Pivot with Purpose: Armed with feedback from paying customers, recalibrate your strategy. Present investors with a clear, revenue-informed roadmap, dispelling apprehensions and setting a course for sustainable growth. Don't pull punches. Embrace the suck and make the hard calls.
In Conclusion
While raising capital is an undeniable necessity for some startups, it shouldn't overshadow the paramount importance of revenue validation. By anchoring their ventures in real-world validation and organic growth, founders can craft a business narrative that stands the test of time and market whims. If you're unsure if you can make money then go find out.
After all, growth is earned, not bought.
A note to founders,
Whether your business is big or small, I've found lots of leaders can get stuck trying to identify MVP or MVS (Minimum Viable Service), I can help. I've launched businesses and products of all sizes and have built design thinking best practices to help drive innovation in Fortune 100 - through those experiences I've learned how to whittle an idea down to it's basics. If you're starting a venture or trying to pivot, I'd love to help you navigate the path ahead.
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