Do startups benefit when big investments come later?

You are going to love this.  Two researchers, Harsh Keller, University of Texas and Maria Roche, Harvard Business School, neither of them having ever started a company, write an article, “Why Start-ups Benefit When Big Investments Come Later,” that is going to try to convince us lowly entrepreneurs that too much money too soon is bad for you.

Throw me in the briar patch.  

I learned that when they are passing hors d’oeuvres, you should take a few, even if you are not hungry, because that tray may not come around again.  I am suspect, but our researchers are armed with some compelling data and they may be right.  Bite my tongue and be polite.

Ask one of the large language models, “Startups benefit from large investments coming later because it allows for more time to experiment and discover true product-market fit, fostering innovation rather than premature scaling or conventional solutions.”

Nice of you to say, pal, but that position assumes optionality that may not be available.  Most startups are dying like dogs in the desert, looking for water in the arid soil.  Only a very few entrepreneurs face the problem of whether they should take the caviar or the smoked oysters.  

For the vast majority of us, seeking to either grow or just stay alive, the basic rule is that beggars can’t be choosers, some money is better than no money, and frankly, who was the idiot (Ludwig Mies van der Rohe) who said that less is more.

But Ketkar and Roche argue that “early funding affects a firm’s ability to develop unique technical innovations.”  In other words, if the classic Silicon Valley investor wants growth and more growth and more users, does that shift the focus from refining the product, adding features and listening to the customer, to pouring on the marketing money they gave you, seeking to bring me the head of Guiseppe Garibaldi and his 1,000 Redshirts.  (And make sure they register to use the app).

What if our entrepreneur wants to build a sustainable company and he/she tells the venture capitalist that they only need a few million at this time, confessing that they are still finding product/market fit. 

The researchers show that “higher availability of funding diminishes the need to experiment and search for technological combinations.”  That is counter to what a VC wants.  Investing a couple of million is mice nuts, because if there is a successful outcome, the VC return on that small investment doesn’t move their needle.  

They need to put out a lot of money, looking for 10-20x, so that one big success will hide the losers they invested in that died.  If they have a $500 million fund and they invest in drips, they do not get an “uncorrelated return.”  VCs are seeking “alpha” – the big bang theory, the one shot that saves the fund.  

You’re selling what they aren’t buying.

At this point in time, my little AI company, a lean and mean group of passionate believers, is horsing around fine-tuning the product, living on a couple of angel investments, where a 10X return on few million dollars is very satisfying, not only to the angel, but also to the employees.

Small bites of money early allow you to experiment. The researchers are correct.  It is still you don’t know what you don’t know time. A large early VC investment often comes with the ask that you go big, even before you know what big looks like.  Blow the dough, and they might hit the eject button.

Many of today’s unicorns only got it right on their second or third attempt at building a product that people would pay for. Ketkar and Roche give several examples of infamous early pivots that saved companies.  Their investors hung in; they tolerated the early missteps.

If you are playing with angel money or small VCs doing seed rounds, you might be buying optionality.  But there is a distinct downside.  You will for sure need to go back to the well, and times change, angels come and go, small investors have shorter time horizons.

When the tsunami comes ashore, only the big VC can save you.  Catch 22.  You will need the life raft.  And that raft is usually sitting on a very large yacht.  Name your poison. 

Rule No. 799:  Brother, can you spare a dime.

Senturia is a serial entrepreneur who invests in startups. Please email ideas to neil@askturing.ai