Inflating Startups by Szymon Janiak

The post was originally published in Polish on Szymon’s LinkedIn profile. Szymon kindly agreed to republish what we think is of great value to our readers.

Startups collapse from excess money. I regularly meet startup founders who think that the main purpose of their business is to raise funds from investors. If they are effective in this and at the same time inexperienced in business, it is extremely often reflected in the company’s cash management. Inflated costs, reckless spending of raised funds, deviation from market realities, – unfortunately, these are often the characteristics of companies that have been financed exclusively with external funds since their inception. 

In principle, there is nothing wrong with this – the role of capital is to accelerate the pace of development significantly. The problem is that the financial structure is often arranged in such a way that the said capital becomes a fixed point of income, which allows you to gain attractive margins. Suddenly, a crash appears on the horizon, investors increase their risk aversion – they want to see traction. The company’s management board makes a decision – we cut costs. And there is indeed a lot of room for reduction, but unfortunately, even after that, the company is very far from achieving profitability on sales and without another financial injection it has no chance to survive. The only thing left is liquidation.

The investors’ money is to increase the company’s growth dynamics, enabling them to incur costs that would otherwise only be available at a later stage. Unfortunately, founders often prioritize expenses incorrectly and cashburn grows in the wrong areas. A larger payroll, a nice startup office, distant business trips, community-building benefits – yes, they are important, but this is a category of costs that should only be incurred when the core business is stable. There are, of course, exceptions – technologies and ideas so advanced that they cannot be built in the short term without the support of investors. However, due to the availability of capital, this vision is starting to rub off: for example, companies building service applications, whose MVP can be made for EUR 25K, but their budgets sometimes have 200K+ in the Pre-Seed round and it’s still not enough.

A special form of pathology is a situation in which external financing becomes the final destination. The founder fights for the next rounds to have something to live on. They have exceptional abilities in attracting investors, and so many have already agreed – but they have a fundamental problem – the market does not want their products or the demand is too low to finance the operation of a company that has gained a certain scale after years. The question is, do they really not see it, or are they just pretending?

The comment section had to add:

In the Polish reality, it is difficult to raise ‘too much money.’

– Mark Friedman, Partner and Chief Growth Officer at Samurai Labs

In my opinion (autopsy), the problem is not in the ‘excessive’ funds raised and payroll, but the lack of a short and long-term strategy, reliable market calculations, and time frames. There is also a lack of supervision.

I have seen many startups that did not even have a well-defined business model, not to mention distribution or marketing, and yet managed to raise large amounts of money from funds. So, maybe we should not expect people who are often just learning how to run a business, often having no idea about finance and economics, to be suddenly able to introduce their product to the market skillfully, without burning funds and sinking their companies.

In addition, time plays a huge role here, which seems to me not to be taken into account (at least by funds). For example, solid, real strategies should be created before the investment stage, not after. This plays an especially significant role in tech startups. After one or two years, you can actually bury the product that will no longer be developed or resell the technology itself if it’s possible.

– Eliza Freit, Managing Director at Instytut Promocji Marki Group

Isn’t the problem about which you write related to the goals set by investors and founders? In the first rounds, when people go for an exit, the pressure to ‘pump’ the company is often very visible. Let’s hire, because it will increase the value of the company. Let’s have a great office, in an expensive location, because it will increase the value of the company.

I have already seen a lot of investment sheets and I am convinced that many of them underestimate revenues, profit and loss balance.

Another fact is that a lot of people want to believe that they are doing deep-tech…

– Łukasz Filut, CEO at PluckyRebels