Venture Capital : Raising the Right Amount of Money

December 8, 2005 at 2:54 am | Posted in Startup | 26 Comments

I think the most common questions any entrepreneur has are always about money — how to get it, where to get it, how much to get, etc. And, sadly, I see everyone always make the same mistake.  They focus on what they can raise but NOT on what they actually need.  Oy.  And I’ve done it myself too.

So here’s my little bit of web 2.0 startup advice for the day:

  1. Understand your own business.
  2. There is an inflection point for any startup where a linear increase in growth or capacity requires a non linear increase in capital needed.

I’ve thought about this a lot lately.  And I mean a lot and I think the best analogy I can make is from architecture.  Reading Paul Graham’s Hackers and Painter’s* book 2 years ago at Foo Camp made me think a lot about architecture.  And I think the lessons from building buildings are very applicable to software.

Lets say you live in the Bayou and you want to build a dog house.  That can be done with a few scraps of plywood, a 2×4 for 2 and Rover’s is just as happy as a clam.  So now you get a 2nd dog and you want to make it bigger.  Well more plywood and another 2×4 or some additional lathe and you can easily double the capacity of the dog house.  No worries.  Now your neighbor asks you to dog sit for them.  Ok no problem.  You make it bigger still and you can hold 3 dogs.  Then all your neighbors bring over their dogs.  And guess what?  Your dog house sinks into the mud.  Why?  Well you never made a foundation.

That’s what I mean about a linear increase in growth or capacity leading to a nonleaner increase in capital.  You could easily double or triple the size of the dog house and rover et al were fine. But when you needed to quintuple it you really had to rip it down and pour a cement foundation or it would just sink into the mud.
Having had lunch with Kevin Burton from Rojo / TailRank a few weeks ago, I worry that he’s making this type of mistake.  Now don’t get me wrong TailRank rocks. But as the quantity of data he’s trying to process expands, he’s going to face this issue.  Heck FeedLounge seems to be in the middle of it. Controversy.  My guess is that WordPress.com / Matt either have hit this point already or will soon.
So I think this is a basic either VC or engineering principle and I’m going to be cocky enough to name it after myself:

Scott’s Law of Funding: Linear increases in growth / capacity will at some point require nonlinear amounts of capital.
I look back at the founders of Google and that giant pile o’ money they took back in the early days ($25 meg from Kleiner if my memory serves me right) and, damn, were they ever right.  Yeah they might a lot richer now and less diluted if they had taken smaller drips as they went but what they didn’t do was ignore this.  Whether by luck or planning they had enough money to deal with this up front.

An Internet Example:

When I built out the first data center for Feedster, I bought cheap switches (D-Link gigabit switches to be specific) for our internal LAN backbone**.  Why?  Well switches are complex and I didn’t know enough to buy the right ones.  Now we’re using *censored* but its an enterprise level switch.  Our traffic may have gone up by *censored* fold but our switch costs went up by *censored* fold but its a nonlinear price increase.

Conclusion

So keep this in mind.  For whatever you do, whatever your startup, there will be a point where your growth rates are going to be such that you need a non linear increase in capital.  Yes I know you’re a hot web 2.0 startup and you’re going to be acquired before then.  Well that’s the plan and that’s always the plan but it rarely actually happens that way.  Sometimes you have to actually operate the thing you’re building and, if so, are you going to be able to.

Footnotes

*If you haven’t ready this yet then you need to.  If you haven’t re-read it lately then you should.  Heck I just did.

**I did however use Cisco for our external facing side.

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  1. [...] FuzzyBlog – Venture Capital : Raising the Right Amount of Money [...]

  2. I worry about it too btw which is why I think capital is important. That said I’m well aware of the issue and grok the scalability problem. Note that Tailrank is running on about 1/30th of the hardware of my previous company due to new implementation details and scalability arch I’ve implemented :)

    Kevin

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