Fund the Answer, not the Question

Some of the most common founder questions revolve around the timing and size of funding rounds. These two components are interconnected. After all, if you raise a large round, you likely won’t need to raise again for a while.

I find that the best way to structure the size and timing of a startup’s financing is to “fund the answer”. What the “question” is, depends heavily on the industry, stage, type of technology and market, and the startup’s needs itself. The founder has an investment hypothesis, or a question, about the future of the startup, and the investor finances the answer to that question. For example, a very early stage R&D-heavy startup developing something revolutionary will have the question “Does it actually work”? or: “Can we even build it?” In this situation, the founders and the investors partner up to answer that question. If answered affirmatively, you have a Proof of Concept. The funding required to test the hypothesis of “We can build it”, may be small or quite large. Again, it depends on many variables, namely the technology and how revolutionary it is (how much further advanced it is from the current state of the art).

As another example, consider an eCommerce company. Such a new startup doesn’t have at its core a question such as “Can we build it” (the required tools have been standardized for over a decade) but rather evolves from marketing-centric questions: “Will people purchase off our webshop?”, then “Can we acquire customers cheaply enough to make a profit per transaction”, then finally “Can we scale above $10mm in revenue?”. Each of these questions represents different phases of the eCommerce startup’s growth, and require different funding amounts (and likely different investors) for each of the periods.

So the right amount of funding is how much is required to answer the question, and the right timing is how much time you’ll need to do that.

Many times pitches sounds like the company is looking for financing without a clear idea of what question they are addressing. In this cases, it sounds like the financing itself will be used to buy time for the company to figure out what the question should be. This implies a lack of strategic focus. This becomes clear when the company is showing promise, but the management is not clear about what the next steps should be. Founders should always be considering the next step and can firmly articulate their strategy showing exactly what the financing should accomplish (according to their hypothesis). Fund the answer, not the question.

This way of thinking has the added bonus of helping to identify the right investors. If you address investors that don’t care about the answer or the question (because it’s not their area of focus or stage of focus), these investors won’t call back. Try to identify investors who want the answers to the same questions you do. These are the right partners.

 

Image credits:
Flickr//User: ed_needs_a_bicycle