Optionality: the "holy grail" for early stage founders
One of the most overlooked considerations when founding teams set out to build a software business, particularly in the b2b space, is recognizing early the variations in potential successful outcomes, and what that may imply about fundraising strategy over the life of their startup.
The default thinking for many founders is: raise an initial "friends and family" round to fund development and show proof points; raise the next round to get some paying customers while refining the product, business model and marketing strategy; raise another round to "add fuel to the fire"; raise more to...you get the picture.
Understandably, startups face plenty of internal and external pressures to assume that funding accelerated growth trumps everything else. For founders and employees, raising new rounds provides validation and perceived value creation. For investors, it allows them to show intermediate paper gains to their investors and an attractive returns trajectory.
In many cases, however, founders don't hit the "pause button" soon enough to consider how business decisions influence future funding. In other words, being more deliberate about growth/cash runway tradeoffs, and strategies that get the company closer to profitability, so that management enjoys three ongoing options: 1. organically build; 2. raise growth capital; or 3. sell the company.
How do founders manage their business so that it's positioned to have as much optionality as possible from the start? Here are a few variables at play:
Business model: how cash cycles through the business greatly affects optionality. Unfortunately, not all business models are created equally. A SaaS company that gets paid upfront on an annual basis can more easily fund itself through sales. In contrast, a business model that requires a "build it and they will come" strategy will soak up capital and have a harder time getting to break-even.
Product/market fit: most startups do not run out of cash building or marketing their product, but because they struggle to find product/market fit. The sooner this happens, and the faster they can reduce "time to scale", the greater the return they are getting from their financial and non-financial resources. This is why bootstrapping for as long as possible is advisable.
Rate of growth: customer and revenue growth can happen at different speeds. In general, turb0-charging growth increases expense burn and will require more frequent outside capital infusions. Setting healthy, but lower growth goals, allows more time for teams to learn how to fine-tune their business economics, and also keeps a company closer to break-even.
Retention & repeatability: ultimately, the health of every startup, regardless of business model, is whether its customers return to buy again without having to re-acquire them. This is the lifeblood for every business and will dictate whether the path to profitability is long or not. Packaging the product to customers and making them insanely happy keeps them coming back, thereby improving the economic efficiency.
Aligned expectations for all stakeholders: from the start, it's key that founders and investors be on the same page on the definition of success and a satisfactory exit event. Too many times, lofty, and unrealistic, goals overshadow other outcomes that could be a win for every shareholder at different stages. Finding aligned investors reduces potential friction and the element of surprise when strategic decisions are to be made.
The greatest freedom in growing a startup is to eliminate dependency on outside equity capital. It's worthwhile to understand the pathway to get to a place where there is a default choice of "doing nothing". In fact, nothing is more liberating than holding all the cards – especially if they include a pair of Aces.