If Your Execs Are Staying at The Waldorf, There’s a Problem

This post by Mike Abbott first appeared in WSJ Accelerators, 11/6/13

Oddly enough, one of the worst things that can happen to a young startup is to raise more cash than the business actually requires. It leads to sloppy management practices that can have lasting ill-effects on the corporate culture.

One basic problem is that, after raising a big round, management teams often feel pressured to spend. Some of the pressure comes internally, as employees used to working on shoestring budgets press for looser spending. Other times, the pressure is self-generated by managers eager to prove to investors that the cash will drive up growth rates.

Having too much cash can lead to lack of discipline. At some startups, the extra spending takes the form of aggressive marketing programs offering questionable returns. Others exhibit an edifice complex, and move into needlessly fancy new offices.

Sometimes, a big cash influx triggers a hiring spree, and standards get lax. Sales people are hired before there are products to sell. Tasks that could easily be outsourced are instead handled in house. Employees begin to get a sense of entitlement. Parties get fancier, perks get nicer. People start flying business class instead of coach, execs start chartering private jets.

Want to figure out if the company is blowing their cash? Find out where employees stay when they travel to New York. If they’re camping out at the Waldorf, there’s a problem.

Over the course of my career, I’ve experienced both life in a richly funded startup – and one skating along with a tiny stash. One thing I’ve learned is that simply raising a lot of money is no promise of success.

During the Internet bubble years, I spent some time as chief technology officer at a company called Electron Economy, which was basically a cloud-based order and warehouse management system. (The term of art at the time was “application service provider.”) The company raised $86 million over two rounds. We burned about half the cash, figured out we weren’t growing fast enough, laid people off and eventually sold the business for about half of what we’d raised. This was a brutal experience.

In contrast, consider Composite Software, a data virtualization company I founded in the darkest days after the crash, in late 2001. Composite managed to raise a small round in the summer of 2002, after I personally funded it for about nine months. At Composite, we bought used cubicles and assembled them ourselves one Friday night. We bought cheap Linux boxes, and were overly frugal on adding new staff. Eventually, the company was acquired by Cisco.

I worry that there’s a new generation of entrepreneurs who didn’t see the excesses of the bubble era first hand. The good news is that more of the companies raising money today are real businesses than was the case in the bubble period. But in some quarters, there are worrisome signs of excess.

My advice to management teams: think of every venture round as the last capital you’ll ever raise. Spend it wisely. Hire enough people to grow the business. Invest in R&D. Sign up smart sales people and marketers. But think of that capital as other people’s money. The road to success is long and fraught with peril. Spend your cash with care, and you’ll improve the odds on turning your startup into a sustainable business.