Over the past 18 months, several Pakistani early stage startups have raised large funding rounds from institutional investors. This is great news for our ecosystem! It shows that more and more founders are beginning to build companies that seasoned investors see potential in. It also serves to inspire others to follow suit and become technology entrepreneurs. If these companies go on to become successful, they will have kickstarted a virtuous cycle of startup formation.
But amidst all this investment pouring in, it is very important to keep in mind that funding is just a means to an end – a fuel for growing your startup. And if you are unable to use this fuel to reach your growth milestones, then you can land in a lot of trouble.
Let’s take a step back and look at how startup funding works.
Investors invest in a startup in exchange for equity, hoping that the value of the startup will grow rapidly and the startup will achieve a successful exit seven or eight years down the line. A good exit will result in the investors making a lot of money. As the startup grows and achieves progress, its value increases. In order to achieve fast progress, the startup usually needs to raise several funding rounds, ideally raising just enough money in each round to reach its next milestones.
At every funding round, the founders are committing themselves to explicit milestones and tasks needed to reach those milestones. They are, therefore, held accountable to the investors. As long as they keep hitting their business and growth targets in each round, the investors remain confident because it shows that the founders have the ability to execute well quickly and that they are resourceful and can achieve more with less. Why is this important? Because without speed and resourcefulness, startups will inevitably fail. Whereas large, cash-rich businesses can afford to be slow, startups need to act quickly because they have a limited runway, and because their competitive edge lies in being closer to the customer and reacting faster than competitors.
What happens when a startup runs out of funds and doesn’t hit the milestones needed to reach their next funding round?
At this point, startups need to raise a bridge round, which is another round of funding from the startup’s existing investors. The main purpose of a bridge round is to help the startup survive and take it to its next funding round. As you might guess, this raises doubts in investors’ minds about the founders’ ability to execute well and also about their ability to manage their cash well.
Only well-funded VCs may agree to such rounds, and that too only if they are the lead investor. And if you are at a very early stage and have raised from angel investors, or from a small fund, or you’ve raised through a SAFE note, then it will be more or less impossible for you to raise a bridge round. Also consider that if you do raise a bridge round, it has to last for about a year or so. And if you are unable to get to the next round after burning through the bridge round, you can safely assume that you will not get another bridge round and will have to figure out another way to keep your startup afloat.
A helpful tip at this point is that it is very important to send monthly updates to current investors. Investors who have not been receiving monthly progress updates will be highly unlikely to give you more money just to help you survive a few more months.
As you can see, having to approach one’s investors for additional funding after running out of money – without having hit one’s growth milestones – is a scenario founders must try to avoid from the very beginning. Therefore, staying focused on one’s targets and keeping on top of growth metrics must be among founders’ top priorities.
At ScaleX, we understand the challenges that founders face when growing their startup and hitting their milestones. We not only help them build the skills and intellectual capital needed to overcome these challenges, but also get involved directly, for example by helping them close sales deals and improving their traction to reach the next round.
Our approach is also unique in that we stress the importance of becoming cash flow positive and “ramen profitable” early on, instead of injecting lots of cash from investors into the startup to fuel artificial growth before becoming profitable. This way, the startups are not reliant on investor money, will not run out of cash, and will not need to resort to bridge rounds. At most, they might need funding to boost their growth rate.
To conclude, founders need to think of their first round as a chance to prove themselves. Only upon successfully reaching their milestones will they get a second chance – otherwise it’s game over.