The Venture Capital Burn-Rate Trap and How to Avoid It

Here’s a move from the venture capital playbook that tends to punch entrepreneurs in the gut:

Investors give your startup a bunch of money to scale, they expect you to hire seasoned people for critical roles, then they start asking why your burn rate is so high.

The next thing that happens is a strongly implied suggestion to “trim the fat.” Then things get dark while you figure out how to cut people without killing both productivity and morale, which, spoiler alert, you can’t. 

Then all the up-and-to-the-right charts go down-and-to-the-right for a little while. Then the investors ask what happened to all that money they gave you.

I’ve seen this happen over and over again, and I’ve actually been caught in this trap myself. I’ve learned that this is all pretty much the startup’s fault, and I’ll explain why.

Venture capital investors love lean teams the same way little kids love birthdays and love cake–so they go nuts over birthday cake. 

In other words, investors love lean teams because of the combined economies of scale:

• If two people each generate X revenue, then working together as a team they will generate more than 2X revenue.

• If that team can make a profit for X cost, then a lean team will make more profit by finding ways to reduce that cost. 

Then crazy projections get made and money gets thrown at it. 

That’s when the trap springs, because economies of scale work on a curve, not a spike, and they always produce friction before they produce results. 

Here are four ways the startup sets its own growth trap.

There’s some ancient conventional wisdom around startups and money that boils down to “If you can get the money, take it.” 

You see this a lot with fundraising. If a startup is in a position to be able to raise money, it should, because the fundraising window can close quickly and without warning.

Once that new money hits the startup’s bank, that same logic applies but now shifts from money in to money out. In other words, “If you’ve got the money, spend it.” So the startup goes on a hiring spree, growing the team quickly with the goal to increase productivity exponentially.

But every new resource takes time to become productive. When you hire one resource at a time, the startup can absorb the productivity hit. When you hire five or 10 or more at a time, it can take months or even years before the startup enjoys the multiplier on the results.

Slow down. Hire one resource, then put your effort into making that resource productive before you hire the next.

When you’re a scrappy startup that suddenly has corporate money, the temptation is to hire in those experienced corporate resources, especially if you can poach them from one or more of the incumbents your startup is trying to disrupt.

But while those experienced resources might be stellar in their current role, that rarely translates to stepping back into their former startup role. They often bring with them all the baggage that turned their former company into the incumbent you are now trying to disrupt, and they rarely want to let that baggage go.

There’s definitely a time to hire resources who can focus on the organization itself, but in the early days–let’s say, the first two or three major fund-raises–those resources are still a luxury.

It kills me when I see the CEO of a 10- to 20-person startup with less than a $10 million run rate hire an executive assistant. Or a brand-new three-person human-resources team brought in to get the startup from 10 people to 100 people in a couple months. 

If you must hire for these internally-focused roles, work with them to strategically redefine that role to either make a better product or sell more of that product. 

Maintaining a healthy company culture is critical for a startup. That culture always tends to disintegrate at around 50 employees, sometimes earlier. 

The worst thing the startup can do here is to start drawing lines around their employees and teams based on who works better with whom, but this is usually what happens. 

The root of the culture problem is that when you hire 50 employees, you hire in 50 different ways of getting things done. If the founders don’t take the time to define, document, and communicate their own methods and strategies before going on a hiring spree, then they leave it to their employees to sort through the chaos.