In the startup world, funding is often equated to success. Funded ventures get a lot of love — often undeserved — from the press and the ecosystem. Take Snapdeal for instance. This e-commerce company was one of the darlings of global VCs, raising over US$1.78 billion in funding from the likes of SoftBank and acquiring 12 companies since inception in 2010. However, the startup failed and is now in talks for a distress sale with Flipkart.

“Entrepreneurial tracks are littered with carcasses of dead startups that were very well-funded, some to the tune of hundreds of millions,” warns Sramana Mitra, Founder and CEO of 1My1M, a global virtual accelerator, in reply to a question ‘could you kill a startup by raising too much funding?’ on Quora.

Mitra, who is also a serial entrepreneur, has posted an under 3-minute video to tell the world how overfunding can result in the death of a company. Titled ‘Death of Nasty Gal, the video depicts the story of ‘Nasty Gal’, which died because of its addition to venture capital. She has also posted the stories of two other companies — Gilt Groupe and Fab.com — which also died due to the same reason.

“Each (of these three firms) started with a promising business. Then each went overboard in their quest for hyper growth without paying attention to fundamentals. Unless you are a Facebook or a Google, a capital-efficient, scrappy strategy is your best bet for success. If you are exploring funding, consider getting an experienced mentor first. Get a mentor who has seen many different scenarios and who knows how to anticipate what could happen next,” Mitra mentions in the post.

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Addiction to venture capital is a common phenomenon among startups. Most entrepreneurs hold the false notion that the media hype they receive through fundraising can be leveraged to attract larger investors. The reality is different. If lack of funding can ground a startup, overfunding can also lead to the failure of a startup.

Serial entrepreneur K Ganesh

“Overfunding can definitely lead to eventual failure as we have seen in many cases,” according to K Ganesh, serial entrepreneur and Partner at Growthstory.in and Chairman of Portea Medical. “If you take the global scenario, Webvan is a good example, which burned a lot of money focusing on things that ultimately did not matter to the consumer and did not affect the business model.”

He supports his argument using India’s case in 2014. India saw several startups getting funded, not just Series A but also Series B, burning through money and trying to scale, well before the business model was established, product market fit proven, or strong foundation laid. Housing.com, and hyperlocal delivery companies like PepperTap and TinyOwl, are some examples.”

He, however, adds that this is not unique to a sector or geography, but it’s more prevalent in B2C business models, or where there is a hurry to establish a brand or do a land grab before everyone else. In his view, it will be less in B2B, or services businesses, which can scale modularly.

There are several reasons for this, he says. “One, you cannot fund your way through a broken business model; you need to crack the code, get the product-market fit and get the consumer proposition right before going all out. Secondly, a company may be trying to work towards its next round funding, trying to hit metrics and numbers for raising the next round at higher valuation, rather than focusing on the core business model. Thirdly, large funding gives you complacency, lack of discipline and focus. You may also try a ‘spray and pray’ approach since you have the money to be able to do it. All this will lead to your shutdown.”

Ganesh further adds no amount of money can save a company unless it has a clear USP. “Competitors are running away with the game due to their strengths, such as better product, innovation, reach, funding and substantial headstart, especially in categories where there cannot be too many players. For instance, the Jawbone case. Wearables, a very tough market, has players like Fitbit, Samsung, and even Apple. So unless you have a solid, clear differentiator and reason for existence, any amount of funding will not save you.”

Also Read: 3 lessons to learn from the shutdown of Indonesian e-commerce platform Cipika

He, however, adds that the solution to this problem is not to avoid raising money or raising smaller amounts, but how to use it. “Lock it up and use it first to prove the model, build a proposition, try different experiments at smaller costs, and see what works and then use the money to scale. Don’t reverse this order,” he underscores.

Shan Kadavil, the co-founder and CEO of FreshToHome, an e-commerce venture for fresh, chemical-free seafood, and former India head of Zynga, agrees with Ganesh, making it clear that it is a fallacy that hyper growth can only come from hyper funding.

FreshToHome Co-founder and CEO Shan Kadvail

“Having been with Zynga during the early times when it was among one of the world’s fastest-growing companies, I can tell you for a fact that the ability to execute in a nimble fashion while prioritising customers matters the most,” he says.

“From my experience, the value came in directly from Zynga’s Founder Mark Pincus. We called it ‘be your own CEO’ internally. What this meant is each one of us ran the company like it was our own money where frugality and innovative ways to grow and prioritising the customer mattered much more than traditional ads- or discount-driven growth. I was fortunate to learn from it and incorporate the same lessons in FreshToHome where we have grown to over 150,000 customers in two years with very little ad spend and mostly word of mouth growth,” he adds.

Another entrepreneur who has been a ‘victim’ of the over-funding of online grocery space, echoes similar views. As someone who has been watching the startup ecosystem in close quarters and with a lot of hands-on experience, he says the moment a startup gets overfunded, it tends to pursue vanity metrics, which eventually leads to failure.

“Startups in the hyperlocal grocery segment in 2015 chased volume (number of orders) and attempted to scale to as many cities as possible. Even VCs were obsessed with the volumes. This resulted in startups building up massive teams to deliver and spending mind-blowing amounts of money for marketing. When the order size was INR 400, the delivery cost was INR 180 and marketing cost was in the INR 100s. So the supposed revenue from the INR 400 sale was less than INR 40. Their focus was to build the metrics for the next round of funding rather than anything else,” he says on the condition of anonymity.

jd_kumai_shutdown

He also observes that many teams take funding as a validation of their idea and product. While startups require continuous evolution to solve customer problems, the team looks at their achievement of vanity metrics as successes. This further accentuates the lack of direction of the firm. “This proves very harmful even when the company tries to pivot. One of the hyperlocal grocery stores, which shut down more than a year back, has not yet been able to find a new business stream or scalable model, despite the availability of heavy investment.”

Many overfunded startups try to start new businesses, he comments. Most of these attempts are motivated by the success of AWS. However, these attempts result in further diluting the focus of the company and wasting several resources. Just look at the acquisitions made by Snapdeal. “Over-funded startups record unjustifiable spends including salaries of several employees. This creates a continuous burn scenario, which cannot be curbed. Restricting them will affect the team morale and exits,” he says. “Most of these aspects make it very difficult for a company to be nimble and pivot to identify and solve a customer’s need in a profitable way.”

Nitin Sharma, former Principal at Lightbox Ventures and a serial investor, cannot agree more: “I have seen many cases, both in the US and in India, whereby overfunding hurt or even killed a startup. I think this happens in two ways. First (and this is more common in early-stage ventures), companies and investors often make the mistake of overfunding before a true product-market fit is established. Based on early traction or hyped storytelling, startups end up raising larger than necessary Series A-C rounds, and money ends up being spent wastefully. A culture of frugality and maniacal focus on product differentiation is often lost, and headcount becomes a proxy for growth. Founders get distracted into starting other initiatives prematurely before basic user loyalty or unit economics are clear. All this effectively creates a weak company not built for scale or to withstand downturns.” 

Nitin Sharma

“The second vicious cycle results from the effects of valuation, and is more pronounced for later-stage ventures. Jawbone, NastyGal, LivingSocial and Fab are a few examples that come to mind. Large rounds come with runaway valuations, often before the company’s metrics can justify them. As soon as such a round is raised, the clock begins and the founder is “riding a tiger” so to speak. If things don’t turn out well, the high valuation gets in the way of future rounds or even M&A exits. Often, you’re faced with down rounds which in the worst cases can lead to a death spiral: anti-dilution, completely different cap table, low morale and diminished prospects overall,” Sharma mentions.

Afsal Salu, Co-founder of Delyver, a hyperlocal delivery startup which was acquired by BigBasket in 2015, however, has a different take: “I was always hungry for more capital, more talent and more time. That helped us innovate to be super-frugal in running Delyver and get one of the best unit economics in hyperlocal delivery (even at a large scale). Once that culture of frugal innovation is set across the company, you don’t lose focus even when large sums are raised in later stages.”

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