<http://schema.org/articleBody>
"Howard Marks is\u00A0a serial entrepreneur and Managing Director of LA tech accelerator\u00A0StartEngine.\u00A0Before StartEngine, Howard co-founded Activision and founded Acclaim Games. \u00A0\r\n\r\n\r\n\r\nRaising money and spending it wisely are two different games.\r\n\r\nIn startup-land, people seem to think raising money is a signal that their business is sound and they should start scaling as soon as possible.\r\n\r\nBut in my experience, raising money has no bearing on whether you\u2019re ready to scale or not.\u00A0 All it says is that the CEO is a charismatic salesperson who gets investors to buy into his or her vision.\r\n\r\nI\u2019m here to argue that yes, raising money is good, but no, it doesn\u2019t say anything about the health or feasibility of your business.\u00A0 Regardless of funds raised, before you\u2019re ready to scale, you\u2019ll still need to do some hard work in what I call discovery mode.\r\nThe wrong reason to spend\r\nWhy should you start spending money? The wrong is answer is \u2018because I have it.\u2019\r\n\r\nThe main challenge, as we\u2019ll discuss below, is that startups need to internalize two conflicting attitudes.\u00A0 First, they need to project confidence to raise money, but be able to switch on their powers of introspection to decide how to put capital to good use.\r\n\r\nA lot of companies forget their roots as soon as they get money.\r\n\r\nThe Founder\u2019s gut wrongly tells them their business plan has been validated because they received an investment. They feel the money can and should be spent on ways to grow the company, so they shift into growth mode by hiring more employees, paying themselves, hiring salespeople, running paid ad campaigns, and spending on overhead.\r\n\r\nWhy do teams do this? In their mind, their fundraising success is a major milestone \u2013 things are different now. Truth is, they\u2019re not.\r\n\r\nI\u2019m here to tell you that you need to worry about this first: graduating out of discovery mode.\r\nThings to consider before scaling\r\nDiscovery mode both promotes and requires mental flexibility.\r\n\r\nThe two most important considerations are team dynamics and where you fit in the market.\r\n\r\nWeaknesses inside the founder team kill startups.\r\n\r\nThe number one reason I see teams fail isn\u2019t because of running out of money, it\u2019s because of quitting.\u00A0 So before focusing on anything else, figure out how you will keep your team excited and stop key talent from quitting. The truth is, sometimes you need to replace your co-founders and start over.\r\n\r\nThe next considerations are \u2018under the hood.\u2019\r\n\r\nYou\u2019re basically tinkering with everything at this stage \u2013 product, marketing, sales, partnerships, etc. You\u2019re learning who your customers are and what they expect.\u00A0 You\u2019re learning what the metrics that matter are, what your funnel looks like, and what actions you want your prospects to take.\u00A0 You\u2019re tinkering with your marketing and sales channels. What sources of traffic are converting, and which channels are profitable, which aren\u2019t?\r\n\r\nThe goal here is to find a situation where you can spend $1 and make $2 back.\u00A0 When you\u2019ve found that, then you can start spending money.\u00A0 But without figuring out all the stuff we talked about above, you can\u2019t spend responsibly.\r\nWhen should you switch from discovery mode to growth mode?\r\nIt should never be the financing event that dictates whether to shift or not.\r\n\r\nInvestors, especially VC\u2019s, argue that the shift to growth mode should be done quickly. They argue that as an entrepreneur you\u2019re always being chased by competitors and want to be a first mover. It\u2019s a big selling point on why to raise VC \u2013 they point out that if you don\u2019t grow, someone else will and they will put your out of business.\r\n\r\nBut I don\u2019t think the competitor is your biggest danger. The biggest danger is yourself. You are far more likely to die by your own sword than wind up killed by a competitor.\r\n\r\nYou have to execute the business plan without executing yourself.\r\n\r\nNew entrepreneurs, no matter how much money they receive, should try to stay in discovery mode as long as possible. It\u2019s what a lot of what the companies at StartEngine do \u2013 they discover, pivot, and change.\r\n\r\nI want startups and first time entrepreneurs to be more frugal and stay in discovery mode longer. But more than just worrying about the money, I want them to understand when it is right to shift from discovery to growth.\r\n\r\nAs soon as that first money is raised, many entrepreneurs try to move out of discovery mode too quickly and shift into growth mode without really thinking their situation through.\r\n\r\nSTOP and ask yourself this question: Am I ready to leave the discovery mode?\r\n\r\nClearly investors should promote the idea that startups need to have clear metrics for terminating the discovery mode. Keep in mind, though, that investors probably are not aware of exactly the challenges the startup has faced and is facing.\r\nMoney comes with strings attached\r\nHere\u2019s a problem I see often: Once the money is raised, investors pressure the entrepreneurs to start spending. Do investors know that this directive is a bad idea?\r\n\r\nNo.\r\n\r\nWhy not? Usually it\u2019s because the founders were doing exactly what they needed to do to raise money.\u00A0 In fundraising, the goal is to show that your startup will be successful.\r\n\r\nHow do you do that?\r\n\r\nPut yourself in an investor\u2019s shoes for a second. Investors are always thinking about growth mode because that\u2019s the path to where they want to go \u2013 liquidity event. If I\u2019m an investor, I want to invest in a company that will use the money I give to them to get ME my money back.\r\n\r\nWhich is a more compelling argument: \u201Cgive us money to figure out our product and finish our discovery mode\u201D or \u201Ctrain\u2019s leaving the station \u2013 are you on board?\u201D\r\n\r\nSo the founder/CEO didn\u2019t transmit the right message because the CEO was doing his job, which is getting everyone excited enough to write a check.\r\n\r\nAs we saw above, the real challenge your face as a CEO is that you need to appear fearless, but have the guts to be introspective about what\u2019s really going on in your business behind closed doors.\r\nYou need to nail your metrics to graduate discovery mode\r\nBefore we go into specific tactics, let\u2019s talk about how to approach finding your metrics like an inventor.\r\n\r\nWhat does that mean? Most people think they know what a tinkerer is, but I don\u2019t think they really do. They see an inventor as someone who, in a stroke of genius, easily discovers the solution to the problem they\u2019re wrestling with.\u00A0 In my experience that\u2019s not how it works.\r\n\r\nI found one definition I like: \u00A0&amp;quot;Someone who manipulates unskillfully or experimentally&amp;quot;.\u00A0 This may seem like a bad thing \u2013 it seems so imprecise.\r\n\r\nWell guest what? This is exactly the sort of work you should be doing.\u00A0 Theories come after experimentalists start breaking things and taking data points.\r\n\r\nI\u2019d like to add my definition of tinkerer: &amp;quot;someone who makes small adjustments and tests a lot of crazy ideas, but doesn\u2019t get discouraged when they fail.&amp;quot;\u00A0\r\n\r\nWhen I was growing up in France, I was always a tinkerer, and proud of it.\u00A0 I\u2019d always be pushing the boundaries of what I could do with my machine.\u00A0 You can\u2019t use theory to find out what people want \u2013 you can only discover it through taking action. \u00A0\r\nHow it applies to your marketing channels\r\nDoing a small-scale test of every one of your marketing/sales campaigns is the exact definition of tinkering. \u00A0 Go into it assuming most of them won\u2019t pan out.\u00A0 Thankfully, when you\u2019re a tinkering with crazy ideas in marketing with a startup, the stakes are low - each time the experiment doesn\u2019t work out, your downside is small.\r\n\r\nBut when your crazy idea does work out, the upside is huge.\u00A0 When you hit, it\u2019s likely to be profitable consistently.\r\n\r\nFor example, Dollar Shave Club created a video that went viral. And my friends, that was a cash cow for quite some time.\r\n\r\nGot it?\u00A0 Now let\u2019s talk about the metrics.\r\nDecide on which metrics really matter\r\nThis will be difference for each company.\r\n\r\nSome metrics that I like to look for are: Lifetime value of a customer, average revenue per buyer, cost of a paying customer, registration rates, etc.\r\n\r\nFor example, if you think the lifetime value (LTV) of your customer is $300 and in reality it is $60 but costs $80 to acquire, you\u2019re going to go out of business. Your company will die. You can\u2019t have a negative margin but make it up on volume.\r\n\r\nThink about a consumer business. You know cost of acquisition at a low scale, so instead of 10 users you decide to test with 100 or 300 users. You now need to see if that particular channel is profitable. Most of the time when buying paying customers through Google Adwords and Facebook you find that the more traffic you buy the higher each unit costs.\u00A0 This is in a way a reverse correlation to what you would expect: higher spending yields lower costs.\r\n\r\nSometimes you\u2019ll see that the lifetime value of your customers has gone way down because now you\u2019re doing volume you\u2019ve harvested all your \u2018ideal\u2019 early adopters. Is the process still profitable? Yes? Wonderful! Good news is you can scale at that metric. Now repeat with every other metric you can think of.\r\n\r\nWhat about your demographic and audience? What do they expect? Can it be stretched? What about different audiences? Try pricing changes. Try the funnel on the website or the mobile app.\r\nThis seems like it\u2019ll take way too long\r\nGuess what?\u00A0 You\u2019re right. Discovery mode will take a long time. It definitely can\u2019t just be done in a day.\u00A0 But I\u2019ll guarantee you it\u2019s worth it.\r\n\r\nJust remember that when you\u2019re in discovery mode, it is ok that you fail some market tests. You can pivot in discovery mode because you give yourself the right to pivot. But when you\u2019re in growth mode, you don\u2019t have the right. When you\u2019re in growth, everyone expects you to grow and expand your user base.\r\nTwo ways to fail\r\nWhat happens to a company that blows through that first million? They turn around and try to raise more money, even though they haven\u2019t hit any of their milestones.\r\n\r\nHow did we come to this?\r\n\r\nInvariably, those unfortunate entrepreneurs who shifted too quickly did so because they were confused as where they were in lifecycle. They made the mistake of thinking they were in growth mode \u2013 spending money on scaling the business \u2013 when they were still in discovery mode \u2013 spending money defining the business.\r\n\r\nOnce the money is spent, young entrepreneurs are usually faced with this situation:\r\n\r\nThe Cram Round - Founders raise money at a lower valuation than the first round and now understand what anti dilution clauses really mean. With the lower evaluation, all the initial investors and the founders will be crammed down and lose a good portion of their equity. If it was a convertible note, in most cases the investors will not convert and leave the founder hanging in no man\u2019s land. Tough situation.\r\n\r\nBurning Up All of their Runway - Founders can also go out of business but then everyone loses.\r\nWhat now?\r\nFounders need to set clear metrics to exit discovery mode and enrol their investors into the process. That partnership will reduce the artificial pressure to scale before companies are ready.\r\n\r\nLike I mentioned above, you are usually your own worst enemy when it comes to building a business. Running out of money because of prematurely scaling is the same as dying by your own sword. That\u2019s why I always advise entrepreneurs I mentor to stay in discovery mode as long as necessary.\r\n\r\nImage credits:\u00A0JUAN BARRETO/AFP/Getty Images,\u00A0BERTRAND LANGLOIS/AFP/Getty Images"^^<http://www.w3.org/2001/XMLSchema#string>
<http://thenextweb.com/entrepreneur/2013/09/29/does-raising-money-mean-you-should-start-scaling/>