How do tech startups get funding? What is the danger of funding a tech company with venture capital?
Tech start-up companies in the early market often run on investment capital from venture capitalists. According to Geoffrey Moore, the author of Crossing the Chasm, there are two pitfalls in relying on venture capital as a source of funding after the product is launched.
Keep reading to learn about the dangers of funding a tech startup with investment capital, according to Geoffrey Moore.
1. Welfare Mentality
When a company runs on venture capital, its survival depends primarily on managing investment risk. Moore explains that sales in the early market are not so much a source of funding for tech startups, but a way of demonstrating that the product is marketable, which gives the financial backers a sense of security.
However, he points out that companies in the mainstream market must be able to sustain themselves on their own profits. Furthermore, he identifies two pitfalls of depending on venture capital for your company’s operating budget. First, he warns that companies running on venture capital can develop a “welfare mentality,” losing their sense of focus and urgency.
2. Hockey-Stick Forecasts
Second, Moore points out that start-ups often use “hockey-stick forecasts” showing no revenue for a period of time, followed by exponential growth of proffits. When sales start to pick up in the early market, these forecasts briefly appear to be coming true, but the growth cannot be sustained indefinitely. Thus, if you make promises to investors based on hockey-stick forecasts, you may not be able to keep them, especially when you come to the chasm.
(Shortform note: In Pitch Anything, Klaff observes that most venture capitalists are well aware of the unbridled optimism that goes into generating hockey-stick forecasts, and thus put little faith in them. He advises that you can set yourself apart and increase your credibility by abstaining from unrealistic projections.)
Consequently, Moore advises companies to become self-sustaining on profits as soon as possible, preferably before you reach the chasm. He asserts that assembling the whole product is the most expensive part of a startup venture, and thus advises you to save the bulk of your investment capital for assembling the whole product during the chasm crossing.
|Self-Actualization in the Early Market|
In High Output Management, former Intel CEO Andrew Grove explains that employees are motivated by a hierarchy of needs, with the highest tier being “self-actualization,” or the sense of achieving your highest potential in life. This perspective, combined with Moore’s warning about a corporate welfare mentality, helps to illustrate an important point about employees’ mindsets in the early market: In the early market, your employees may feel they’re achieving their highest potential simply by taking a revolutionary idea and turning it into a working product, regardless of how well it sells. Their sense of self-actualization comes from advancing the state of the art, not from building a profitable business. This works at first, when you’re running on venture capital and doing the initial development work, but, as Moore warns, it can drive the company into a welfare cycle: You’re more interested in developing new technology than making money, so the technology you develop isn’t focused on a profitable market sector. Thus, you don’t bring in enough sales revenue to become self-sustaining, so you continue to run on venture capital, which allows you to continue to focus on developing new technology instead of making lower-tech refinements that would make your product more marketable.
To break this cycle, employees need to view the profitability of the business as a higher purpose than simply developing innovative technologies. This shift in mindset is not easy for most people to make.
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Like what you just read? Read the rest of the world's best book summary and analysis of Geoffrey Moore's "Crossing the Chasm" at Shortform.
Here's what you'll find in our full Crossing the Chasm summary:
- An explanation of the chasm phenomenon that many new high-tech products face
- How to pilot a product across this chasm to mainstream success
- The problems with the Technology Adoption Life Cycle (TALC) model