Why raising too much money is worse than too little

After the successful sale of Course Technology, Inc. to Thomson (now Thomson Reuters), we had no problem raising capital for my next company, Mainspring Communications, Inc.

Unfortunately, we raised way too much money: $8 million dollars for nothing more than two guys and my business plan – which was untested and fatally flawed. Mainspring was born back in mid-1990’s when the Web was just starting to take off commercially. What I thought was the opportunity was to help the thousands and thousands of corporate IT staff to transition from PowerSoft and other legacy applications to Web tools and technology. My model was MSDN, the Microsoft Developers Network. And that was the fatal flaw. Obvious in retrospect, but the idea that Mainspring, like MSDN, could actually charge developers for access to information and tools when everything else on the Web was free, was sheer folly. In fact, Ziff-Davis and all the ad-supported PC tech publications quickly built web sites and gave away the type of information we were creating and trying to sell on a subscription basis.

Worse yet, were were paying staff to create this content, but revenues were no where in sight. However, raising so much money at stage zero enabled us to focus on hiring, buying expensive software (like Oracle!), developing a sophisticated platform complete with credit card processing, taking on large, costly office space, and otherwise focusing solely on the supply side of the marketplace equation. We cheerfully ignored customers completely – we arrogantly thought we knew what they needed – until launch day.

Once we launched, it didn’t take long to find out no one wanted to pay for a subscription to Mainspring, which was barely a “nice to have” vs. MSDN, which in a then Microsoft monopolized world, was a “must have”.

After losing the internal battle to pivot to ad adverting business model, I left the company, only to see it pivot twice more and eventually end up as a consulting company that went public and then was bought by IBM. As I recall, it took them multiple more  rounds of funding to pull off this feat. (As a side note, much to my frustration, a company called Earthweb later basically cloned the Mainspring idea, but with an ad-based business model, and went public well before Mainspring did, at a $700 million valuation.)

But the moral of this story is startups need to be lean and hungry. That forces them to get their product to market quickly and start creating customers vs. spending months and millions building a product no one wants. We were fat and self-satisfied – the formula for failure.

These days with all the open source tools and knowledge out there, building a product is orders of magnitude cheaper than it was twenty years ago. In fact, many leaders in the startup ecology advise against raising venture capital period. VC money, if you raise it, should be used to scale, not build. Too bad the book Nail It, Then Scale It was published twenty years too late for me!

So raise friends and family money and liven on Ramen noodles while you build your product and create customers. Lack of capital is a great forcing function to get stuff done fast and validate your product idea ASAP, since only then will you be able to raise money from professional investors. And when you do, don’t make the mistake I made by raising way too much. The rule of thumb is to raise enough to get you through the next 18 months, with perhaps a 15% cushion. Or better yet, to base your raise on getting to very well instrumented milestones or the road to scaling a product that already has customer traction – known in VC-speak as “staged capital infusion”.

Author: Mentorphile

Mentor, coach, and advisor to entrepreneurs, small businesses, and non-profit organizations. General manager with significant experience in both for-profit and non-profit organizations. Focus on media and information. On founding team of four venture-backed companies. Currently Chairman of Popsleuth, Inc., maker of the Endorfyn app for keeping fans updated on new stuff from their favorite artists.

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