Startup funding can be a delicate dance, especially when one or more angel investors are providing the cash. Like any complex set of gyrations, spoken and unspoken social conventions overlay the basic rules and provide much of the charm and frustration. Of course, the underlying purpose is very simple and never varies. The startup needs money and the investor needs to splash his or her cash. Don’t forget the second part of this. Every investor has limits and boundaries but fundamentally they want to find a reason to spend. Because of the rules of the game, one simple piece of information is often obscured or even totally overlooked. Crunch question for the founder/ CEO/ Chairman - how will you spend the money?
If this seems too obvious, think about the follow up question which often causes much angst. Are you asking for enough? Amongst investors at least, this question usually results in a debate of knowing nods and wise generalisations. In other words, opinion and ego rather than answers. Startups teams take a different approach. The fundraising target often comes before any form of business plan so the story is designed to justify the numbers rather than being the outcome of any strategic thought.
All of this arises because it is not actually such a simple question. Answering it requires an understanding of some big levers in the business model and an ability to make some tough choices. Both pretty valuable qualities for a CEO to demonstrate. I have just made an investment in Mallzee and the way Cally Russell, the CEO, answered these questions was a big factor in my decision. What was going through my mind?
There are basically three ways to spend the money. Sales and marketing effort to achieve growth in revenues, developing the product to enhance user reach and engagement or overheads necessary to provide and managed environment for either or both of the first two. The key challenge is to understand how money spent in each category leads to revenue and cost. Remember, this can usually be predicted and measured in the online world. Initial estimates based on concept products, minimum viable products or marketing experiments may prove to be wrong. Seeing this, adapting and understanding are part of the growing pains but the startup should have some data to use as a starting point.
Using this data should enable the CEO to predict how money invest in this area converts to revenue and thus make a direct link to the cash burn. Money spent on product development may be harder to measure. Sometimes, the link will be simple. Making a successful IOS app available on Android for example. In all cases, quality and reliability of product underpins user engagement and loyalty which in turn support stability and growth in the revenue line. Planned investment in development should at least be pointing in this direction.
I can already hear teams complaining that success needs money in both these areas and in overheads to back them up. Very true. That’s where your startup turns from a project into a business. Choices, choices, choices. No-one has unlimited funds. The track record of business which have money to burn is pretty dreadful anyway. Such companies usually lose the focus and urgency which made them rich to begin with. Good businesspeople understand that their primary function is to make decisions. In most cases making the wrong decision three times out of four will outperform no decision by a very wide margin.
So no easy answer but a crucial question. Any investor will tell you they invest in people ahead of product. For me, one of the key tests is how people answer this question. I don’t expect to see a spreadsheet with precise answers. I am looking for an understanding of the choices available and how to balance them as things unfold. How would you spend more money if you were offered it? What could you achieve with less?
A final thought. How an investment is spent should translate into a financial outcome which in turn leads to figuring out if and when more cash is needed which naturally takes you to the next investment round and which ultimately gives a picture of what an exit might look like. Pretty important area to think through...
Kenny Fraser is the Director of Sunstone Communication and a personal investor in startups.