Category Archives: Startups

The Psychology of Startup Funding (in a nutshell)

At the suggestion of an acquaintance of mine who works for a sort of an Angel / Incubation firm (they provide both capital and leaders for companies in their portfolio), I spent some time last month refreshing my understanding of the psychology and mechanics of startup finance. (Although my current company works with a number of startups as an outsource product development partner, and I’ve been involved in obtaining funding while working for startups in the past, I haven’t done as much recently.)

The tension between investor, founder, and customer creates an interesting drama. I don’t have the bandwidth at the moment to write much about the subject, but here’s the bottom line:

  • Startup founders must be passionate about their product and their customer, otherwise they aren’t likely to put in the effort and obtain the insights they need to succeed.
  • Investors, both current and potential, are passionate about acquiring as much of the company as they can for as little as they can spend, then selling the company for as much as possible as soon as possible.
  • Thus, while the compelling value proposition for the customer resides within the product, the compelling value proposition for the investor lies within the exit — the likelihood that more than one larger company is going to pony up a large sum of money for the company (noone IPOs anymore).
  • Being attractive to potential investors is important to keep in mind because you’re going to need them down the road and have to start designing the company around that need before you even start it.
  • When a startups needs money the most, investors will cheerfully take advantage of the opportunity to cut everyone else out of the picture (read about “down rounds” and “full ratchet dilution” for glorious examples that most non-finance folks find counterintuitive at first glance).
  • Thus startups need low “burn” relative to their current funding, to avoid finding themselves in the position where they have to give up a lot of equity just to keep the lights on. They also need to show ever increasing success metrics (numbers of users, gross revenues, transactions, customers, what-have-you) in order to keep investors excited about the exit.

While you’re waiting for more from me on the subject, check out this excellent series of posts in Brad Feld’s blog (Brad is a Colorado-based venture / angel capital guy with a huge amount of startup experience): Brad Feld’s Term Sheet Series (a term sheet is the essence of the deal struck between a startup and investors).

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