Why Do Start-ups Need Investment?

Continuing from the previous post on market opportunities for start-ups, this post will focus on the funding aspect of it. There are various schools of thought in the start-up world when it comes to funding. There are some who believe that investment only ruins companies, while others think of them as enablers and as necessary evil. The key to understanding your need for funding is often found in the opportunity you’re trying to target, so let us figure it out from that point of view.

Before I get going on the four opportunities, the one thing I’ll be very clear about is that there is no golden rule to all of this. Business and funding environments change regularly and every major player in the ecosystem (companies, funds, public markets) all respond to changes in the larger economic climate. So, if anyone shows you the rulebook, pointing out the One True Way™ to grow your company (with or without raising money), feel free throw throw away that book.

Why Do you need investment?

To De-risk: You can always build flying cars using your own money, if you have enough in the first place, or you can attempt to get that money from someone who is better positioned to absorb the losses should flying cars fail.

To Build: You have to put together the first version of the flying car. This involves buying tools, fabricating parts and a thousand other things. Sometimes you may not have the money on yourself to do this without financial help from the outside.

To Validate: A car once built has to find buyers in the market. Even the best built car, kept as a secret in your garage, won’t sell. If it won’t sell, you don’t have a business.

To Grow: The cars are selling well, but you can’t meet the rising demand with your existing infrastructure. You also want to expand into a different geography because you’ve saturated the market for flying cars in your current geography. This involves hopping up through the stages I had mentioned in a previous post.

To Diversify/Consolidate: The flying cars are flying off the shelf, you’re thinking big now and you have hit the limits of efficiency with the current set up. Growth has to come from elsewhere and M&A becomes a viable option within and outside the car industry.

You also realize that you are spending a lot of money in marketing and discounting the prices (thus adversely affecting the margins) to compete with the New Flying Car Inc. A quick look at the balance sheets says that as a combined entity you can be more efficient and improve the margins by an extent that justifies the risks involved in the merger.

The case for not needing investment!

You can build companies through all the four stages listed above without taking on any investment. There are a lot of profitable businesses that were built and continue to run successfully in this manner. These vary from companies of a substantial size to  mom-and-pop stores.

But these are also companies that tend to grow slowly and the odds are, you won’t find much sought-after hockey stick growth in companies that did not take investment. Exceptions are there to this story, but the norm tends to be that to get into the hyper growth stage, companies need some form of a force multiplier in place and the most obvious and organized one available there is capital.

Risks in taking investment & hyper growth

Investors rarely put money into companies for charitable or altruistic reasons. It is important to understand that they’re also running a type of a business that has a substantially high rate of failure. Funds are raised often for a 5-10 year window and to be successful they need to handsomely beat any other investment class out there.

Trouble is that organic growth companies rarely get massive in a 5-10 year window. This is the reason why the hockey stick growth curve is much sought-after by the investors.

The risk with hockey stick growth, though, is that it compress a lot of events and factors into a very very short window. This is similar to human being going from an infant to a full grown adult in an extremely short period of time. Even in companies, you have both Macaulay  Culkins and Dakota Fannings.