Fundraising Acceleration as a Flawed Paradigm

For the last 12 to 18 months, the private technology market has seen sky high valuations and a significant disconnect from the public markets. Recently, much talked-about startup Slack raised $120M at a $1.12B valuation with just $1M in monthly revenue. My friend, Danny Crichton, wrote a really insightful piece on TechCrunch regarding this new trend of “fundraising acceleration”.

Crichton outlines the factors that have created such a fundraising strategy and also carefully points out the disadvantages of raising too much at too high a price. Namely, he highlights the increasing bifurcation of the have’s and have-not’s (high and low-growth companies, respectively), as well as consequences with equity compensation for employees.

Here are some pitfalls I see with this kind of investment strategy:

  • High risk of a down round: Macro conditions are nearly impossible to predict. Unless the mega round is meant to fully fund a company from one bull cycle to another, it’s likely that the next funding round will be a difficult one.
  • Capital inefficiency: This type of fundraising strategy is also counter-intuitive to the lean startup philosophy. Raising such a large amount of capital creates negative incentives to be capital efficient, and in the hands of an un-experienced team, can lead to higher burn rates.
  • Increased execution pressure: With a valuation so far beyond fundamentals, management teams will and should feel an increased pressure to perform. It’s no longer enough strive to deliver on a vision you’ve sold because you’ve already committed to deliver it. Traditional “Plan B” options, such as acqui-hires, will become harder to sell to the board.
  • Diminishing returns: The reason that market leaders are often rewarded by an order of magnitude is that idea that in a networked world, winners take most (if not all). With funding acceleration, VC’s are not only increasing the risk of betting on the right horse, but also driving down their own gains. As the adage goes, capital flows into an asset class until returns revert to the mean. When that happens for the VC asset class, it’ll be a painful day for those holding such over-valued assets in their portfolios.

Crichton also writes, 

The person who most popularized this notion of investing was Marc Andreessen (who ironically also happens to be one of the earlier investors in Slack), as well as Peter Thiel, whose experience with Facebook’s growth encouraged his investment thesis for Founders Fund.

While I’m a big fan of both, we should also consider the fact that neither of these two investors have long enough tenures as VC’s to have experienced a downturn in the markets, and more specifically, a downturn within the technology sector.

The Path less traveled by…

I’ve been wanting to write an article on Path for a while. When I first discovered it this February, I signed up right away. As an amateur photographer and someone who always thinks twice before posting something on Facebook, I welcomed the levels of privacy that Path offered, as well as the simplicity of sharing moments through photos. (There’s a Kodak slogan lawsuit in there somewhere.)

Several issues prevented me from becoming as much of a Path user as I wanted. It was very difficult to find friends who also used the service. While Path did encourage me to tap into my Facebook network to recruit friends, it didn’t do much other than the usual referral screen after sign-up. I recently encountered a company that plays this referral game much better by allowing users to unlock a premium version of its service simply after inviting 5 friends. 

Even today, with a network of over 1200 friends on Facebook, I only have a handful of contacts on Path, and none of them are regular Path users. What disappoints me the most is that Path doesn’t seem to be correcting its lack of network effects – there is never a prompt or encouragement for me to return to the service (via e-mail or text), or to search my social network again to see if new friends have joined. 

Secondly, I never got around to using Path because it was also hard to share any photos without an Android app. By the time they’d released a beta version in June, I had long since abandoned trying to get this service to work for me. It’s also clear that the app needs some work; it only has a 3-star rating on the Android app market. 

When I read about Path nearing the 1 million user mark, I couldn’t help but immediately think of Eric Ries and his cautions against vanity metrics. I’m certain that a significant portion of the 1 million users are disengaged like me, and who have signed up but never regularly logged in.

There already isn’t much to do on Path, due to the lack of network effects, and Path’s simple web interface is detrimental for retraining its users at this point. Here’s a couple of immediate things that Path can integrate to increase user engagement:

  1. Target those people who already actively use photo-sharing services, such as Flickr or Instagram. Many people don’t immediately think of whipping out their cameras when something interesting is happening, but those who have adopted this habit must already be posting their photos elsewhere on the web. 
  2. Help me filter my closest friends on Facebook so that I can target, invite them, and convince them to start sharing. There is no doubt that everyone has that close circle with whom they’d love to share almost everything. (I’m currently addressing this social need with the use of GroupMe.) Path just needs to make it easier for me to move that circle onto its platform.

Path has already lost a lot of its initial steam. It’ll take a lot more than a well-positioned TechCrunch article to reinvigorate it.  

The Path less traveled by…