Startups: Misadventures in Spending

Startups: Misadventures in Spending

A Look at Some of the Pitfalls of Allocating Capital

Nov. 6, 2013 3:42 p.m. ET

Raising capital is a challenge for most startups. But those who do so successfully then face the dilemma of figuring out how to best allocate the funds. With the temptations of plush office spaces, perks and high salaries, a startup’s so-called “seed” funds can quickly disappear. Founders have to decide which part of their business would benefit the most from added money. This week on The Accelerators, a Wall Street Journal blog on the challenges of starting and growing a business, a group of experienced entrepreneurs and venture capitalists shared their views on the pitfalls of poorly allocating startup capital. Edited excerpts:Learning to Work With Dough

Pizza made me who I am. In the summer of 1998, I dropped out of college and started a pizza restaurant called Growlies in my hometown in rural Canada.

The lessons that restaurant taught me on allocating capital helped me avoid some major pitfalls when getting my social-media company off the ground a decade later.

Lesson one: financial discipline. During the early days of HootSuite, when social media was still seen as a fad, I made the decision to treat our funding as if it were my personal bank account. I looked at those dollars as if I had personally earned them and wasn’t about to give them up without a fight.

But there are some corners that shouldn’t be cut. Cheap ingredients will sink any pizza joint, no matter how good the marketing is. The same principle holds true for tech.

Pizza taught me one last lesson on capital allocation: Get into the black and stay there. Basics like revenue and financial viability are too often taboo topics in the startup world. But I feel it’s critical to have money coming in and to hammer down income streams sooner rather than later.

Ryan Holmes, founder of HootSuite Media Inc., Vancouver, British Columbia.

How I Kicked My Free-Pen Addiction

Startup founders fall into two common traps when allocating capital. In the earliest stages of startup-hood, founders often will underspend on customer-focused work, which should actually be the No. 1 priority. In later stages, founders will underspend on non-customer-focused infrastructure.

During the initial testing phase, new companies face the delicate proposition of approaching potential customers who have little interest in what they sell, or who are unfamiliar with their businesses. If you don’t want a customer’s first interaction with your product to be his or her last, it’s worth devoting serious resources toward ensuring that the initial encounter is amazing.

A second common mistake occurs at a later growth stage. If you’re lucky enough to make it through the fire and generate traction, it’s important to recognize that you’ve entered a different stage of the business and can no longer afford to be extremely stingy.

An embarrassing example at Warby Parker involves pens. I had always been adamant that the world was filled with free promotional pens and there was no reason to purchase additional pens for the office. (Thank you, TD Bank). At the point when we had 50 employees, our office manager approached me and asked if he could finally buy pens. Before I could squash the idea, my co-founder and co-CEO Dave Gilboa started laughing and cut in: “Yes, we can buy pens. Neil, you’re crazy.” With that, the pen embargo was lifted.

Neil Blumenthal, co-founder and co-CEO of Warby Parker, New York

What ‘The Bachelor’ Teaches Us

Some startup journeys remind me of dating shows. Someone becomes infatuated with an idea; he or she rushes to build something, anything, that works; he or she then becomes too emotionally invested in the product and thus unable to see (let alone fix) flaws in what’s being built; the founder then spends resources on going too big too fast. These startups inevitably fail.

What can entrepreneurs learn from Jake Pavelka, Ben Flajnik and the other great men of “The Bachelor?”

Don’t let infatuation cloud your judgment.

Entrepreneurs are passionate people. They are often visionaries and innovators. It’s easy to become infatuated with one idea and subconsciously commit to it, even though it may not be the best one. Passion is important, but don’t follow it blindly.

Don’t become a slave to an arbitrary timeline.

Startups are designed to grow fast. But that doesn’t mean trying to move fast from day one. In the earliest days, set a pace and goals that maximize learning, and be willing to adjust as you get new insights.

Don’t make a lot of noise before you’ve found love. Find a real fit first.

Of course you want to tell the world about what you’re building. And you should spend money and energy to do that whenever you are really ready. But take the time to find a real (product-market) fit first. Waste your resources on the things—ads, marketing, PR, etc.—that will help make you feel big and important in the very early days, and you will lose.

Jessica Jackley, investor at Collaborative Fund, Los Angeles.

‘I Got Debts No Honest Man Can Pay’

There’s a wonderfully depressing song by Bruce Springsteen in which he says (on behalf of the protagonist): “I got debts no honest man can pay.” Sometimes people find themselves buried under crushing debt, and sometimes people take big gambles that pay off.

Startup founders have to gamble. It’s even fine for startup founders to gamble with OPM (other people’s money), but they must have made good disclosure to the people whose money they’re using.

This also applies to the way startups treat team members. For instance, I’ve seen founders who have convinced people to join their startup only to have overestimated their startup’s ability to make payroll over the next several months. People definitely have long memories for these kinds of mismanaged expectations.

If you can’t convince vendors, developers, employees or others to knowingly share the risk, don’t compel them to unknowingly participate or you’ll end up with “debts no honest man can pay,” and that depletes reputational capital.

Ed Zimmerman, founder and chair of the Tech Group at Lowenstein Sandler, New York