Startup general interestVenture Capital

Premature scaling at Series B

By January 22, 2014 No Comments

PandoDaily has an article up entitled The Series B trap, that’s about the dangers of premature scaling. It perhaps happens most at Series B, but can certainly happen earlier. In my experience this is one of the hardest points for many entrepreneurs to grasp. Everyone gets the idea in theory, but many fall into the trap of thinking that they are different and it won’t happen to them. It all comes down to probabilities in the end – anyone can get lucky – the trick is getting a handle on how lucky your plan requires you to be…

The article describes how it goes wrong in two ways, firstly:

  1. Your company is growing and scaling well, often on little invested capital. You decide you’re ready to scale and raise millions, so you pitch big venture funds on a big growth story.
  2. Investors pay a high valuation to get into a good deal, betting on continued fast growth.
  3. To meet growth and revenue targets, you hire and spend like never before. You rush a few key hires, overbuild the team, ramp marketing spend. A few quarters in, you realize that product/market fit is not quite there, or you’re not as far up the sales learning curve as you thought, or your LTV/CAC is suddenly in the toilet.
  4. But it’s too late to change course. After several consecutive quarters of high burn, missed targets and lowered expectations, you’ve wasted a year and $10M. Investors who paid up for your financing are not happy.
  5. You fall into the spiral of death: head of sales gets replaced (at least once), CEO gets replaced (at least once), a down-round financing happens (if lucky).

and secondly:

With more money in the bank than they are used to and investor expectations to meet, companies start spending soon after the capital influx, driving down LTV/CAC, bringing in non-core customers (churn!), hiring B players to fill the roster and generally doing everything they avoided when they were running lean and smart. As we’ve written before, sometimes it just takes time to find product/market fit, or climb the sales learning curve. As many entrepreneurs have painfully discovered, pouring gasoline on the kindling isn’t usually the best way to make a fire.

It’s counter-intuitive, but too much money can kill a company.