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Lessons Learned

The Case Against Startups Raising As Much Money As Humanly Possible

The most innovative businesses are sometimes built at times of need and on a shoestring budget.

[Photo: Everett Collection via Shutterstock]

"Necessity is the mother of invention," the saying goes. But what happens when inventors start imagining their necessities are far greater than they are? That's a question that more entrepreneurs should consider seriously. The most innovative businesses are often built at times of need—and on a budget.

Innovation In Times Of Need

Most of the things we think of as good today happened because something bad happened yesterday. Nothing brings people to action like stress and necessity.

Famines forced us to learn how to be more effective farmers. Pandemics forced us to find vaccines. American medical professionals didn’t realize how effective penicillin was until World War II sparked frantic research in order to care for U.S. troops. It was much the same for modern airplanes, nuclear reactors, and highways. The supermarket was born during the Great Depression as a solution to make shopping more efficient for consumers who didn’t have a dime to spare. The list of modern technologies owing their existence to the exigencies of the Cold War is too long to list.

It’s hard to admit that people act more efficiently during hard times, because no one truly wishes for hard times. But we know it’s true. Focus is most powerful when it's addressing an urgent need, rather than a want. The uncomfortable corollary is that what many entrepreneurs strive for—success, deep pockets, a comfortable lifestyle—can wind up backfiring in ways that are hard to foresee.

When Zynga went public several years ago, it warned investors of an odd problem: "Many of our employees may be able to receive significant proceeds from sales of our equity in the public markets after our initial public offering, which may reduce their motivation to continue to work for us," it wrote. It was a surprisingly candid admission that highlights how tricky the relationship between current success and future innovation can be. Zynga's employees were actually too successful to be motivated.

The same applies to businesses. Innovation typically doesn’t happen in the cradle of deep pockets; it happens at companies with limited resources that need to solve problems fast or close shop. In the middle of last decade, Tesla reinvented the modern automobile for one-tenth the amount of money General Motors and Ford were paying annually to idle employees who had nothing to do.

The Wright Brothers were far from the only ones trying to create a functional airplane in the early 1900s; another group of well-heeled entrepreneurs were in the chase. But while the competition could fund grand designs and test flights, the Wrights were blessed with scarcity. Having to make do with what little they had made them more open to tinkering on the spot, less wasteful with resources, and driven to really understanding the mechanics of flight before launching another costly test. Wilbur once outlined his philosophy on money: "All the money anyone needs is just enough to prevent him from being a burden on others." Too much could be just as burdensome as too little.

Disadvantage In Disguise

Nassim Taleb wrote in his book Antifragile, "The record shows that, for society, the richer we become, the harder it gets to live within our means. Abundance is harder for us to handle than scarcity . . . The excess energy released from overreaction to setbacks is what innovates!"

This raises the question of whether young companies should raise as much money as they can from deep-pocketed investors. Too much money—which is to say money that you don’t absolutely need—can do worse than just dilute a founder's ownership stake. It can undermine the fundamental motivation that comes from scarcity.

We saw this during the dotcom boom. An easy flow of capital made entrepreneurs' ability to dream of things greater than their ability to actually do them. It happened again during the housing bubble. Easy credit, which was originally associated with having options and flexibility, ended up letting people throw values and prudence to the wind.

This isn't to be a scold. It's to remind every entrepreneur and business leader of the context (and constraints—often healthy ones) that we all operate within. While it's true that access to outside capital is the lifeblood of our economy, it's also true that for a lot of businesses, it’s entirely possible to self-fund, bootstrap, or raise a little bit of capital from friends, family, and traditional bank lending and still be successful.

You Probably Don't Need VC Money

Actually, it’s the norm. According to a 10-year study by the Kauffman Foundation, venture capital as a source of funding isn't nearly as common as you may think. The study found that 71% of the companies were financed by either personal savings, investments by friends and family, or traditional loans.

Only 4.8% of new businesses obtained funding from VC firms and 6.3% from angel investors. In fact, credit cards (6.8%)—among the most expensive mechanisms of financing—were used more often by startups than either angel or venture funding. The Kauffman Foundation also looked at the Inc. list of the 500 fastest-growing startups and compared them with businesses started across the U.S. Researchers found that the percentage using venture capital was only slightly higher—a difference of just 6.5%.

Take Shutterstock. Jon Oringer started the company with $10,000 and never took any venture capital. Shutterstock went public in 2012 and has a market cap of nearly $1 billion. Epic Systems is one of the biggest health care software providers in America, with revenue of nearly $2 billion per year. It is privately owned by founder and CEO Judith Faulkner and has never taken any form of investment.

MailChimp, the email platform, is the same. It recently wrote something that sums this up: "Since MailChimp is self-funded, profitable, and quickly growing, we spend our time improving our product and listening to the people who use it. We chart our own course, and relish the freedom to make bold decisions." That's an incalculable advantage that would benefit so many companies.

Not every business should strive to self-fund. Many can’t. But there is an irony that's easy to overlook: In our quest to succeed and become more comfortable, sometimes the best thing we can do is insist on being a little uncomfortable. Discomfort—in the form of not raising as much capital as you possibly can—can help you stay focused on what really matters. It keeps you grounded. Mae West said, "Too much of a good thing can be wonderful." But it can also be a curse.

Craig Shapiro is the founder of Collaborative Fund, and Morgan Housel is a columnist at the Motley Fool.