Why Do Innovative Companies Consume So Much Startup Capital?
The following is adapted from More Good Jobs
Imagine walking into a startup meetup and asking the first founder you meet why private capital matters for startups. If they’re like most founders, they will look at you with a blank stare of silent confusion.
Asking a founder why capital matters is like asking a fish why water matters — it’s such an ubiquitous part of their ecosystem that they can’t even imagine a world without it. Startups need capital to get off the ground, and generally, the more innovative the company, the more capital they require.
It’s not hard to see that creating anything unproven in the market is more expensive than copying an existing business model, but what exactly makes startups so expensive?
More than anything, the time, talent, and problem solving that startups require to create or overtake a market makes outside capital a necessary part of the entrepreneurial process.
Problem Solving Costs Money
When you’re solving a problem that no other company has tackled, you’re probably starting from scratch. That means laying the groundwork for your solution, making mistakes, and refining every step of the way — all of which consumes time and money.
Whether the startup is creating a product, service, or technology, there is a lot of problem-solving and customer discovery required to iterate a solution that can scale up to large volume adoption beyond a local marketplace.
Sometimes with a narrow, technology-based innovation that is timed to ride a host of marketplace drivers (e.g., WhatsApp, Instagram, etc.), it is possible for this growth to scale up incredibly quickly. But these are the exceptions, not the norm, as most businesses will go through a series of iterations to tune both the product or service and the path to growing new customers.
Startups Must Educate Customers
Not only do startups need to problem solve, but they also must educate their customers on their innovative solutions. The challenge of educating customers to become early adopters is a big hurdle when you are asking them to stop doing something they are already familiar with.
People are naturally resistant to change, so there’s a burden of proof on the startup to show why the new solution is better in a way that the customer never heard of or thought about before.
Startups also have to convince customers that the risk they’re taking by trying an innovative product won’t backfire. For example, if you opened a hotel, people would instantly understand what you do. But as Airbnb found, even with their Silicon Valley start and backing of legendary startup investor Paul Graham, it proved to be a lengthy process of discovering the right mix of education paths and risk-mitigation mechanisms to drive adoption for allowing strangers to sleep in one’s own home.
For many innovative companies, earning their customers’ trust requires a significant investment of time and money.
Innovation Requires Expensive Talent
Lastly, startups in newer industries consume so much capital because they require expensive talent to solve their problems.
People who already have plenty of other opportunities and sufficient demand for their specialized skills can’t be hired on the cheap, and startups don’t need only one of these workers — they need a whole team.
It’s not realistic to assume that the innovation of a single founder will be enough to cover all the functions encompassed in building a true company that scales up to meaningful levels in headcount and revenue.
This team alone requires a large amount of capital to cover salaries while the startup is gaining momentum and building its revenue stream.
Capital Gives You a Competitive Advantage
With these factors in mind — the problem solving, education, and talent required to succeed — you can imagine how easy it is for an innovative company to consume capital. Most startups simply won’t have sufficient revenue growth soon enough to power through the long product and customer development cycle, so they need significant external capital to get off the ground.
The good news is that in today’s market, you can get a startup up and running faster than ever before. By taking advantage of cloud-based services such as Amazon Web Services or Microsoft Azure, plus prebuilt shopping carts and other online transaction tools, you can build a professional website and start selling your product or service in a single afternoon.
The downside to this is that there’s also more competition than ever before. That’s why one truth about startups will likely never change: capital gives you a competitive advantage.
More money means more talented people creating your solution, more marketing, and more customer education, all of which give your startup the best chance of success.
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