This is the second post in my Scylla and Charybdis series on why startups are quite so hard. Up today: hiring. Here you can go wrong by hiring too fast but also by hiring too slow.
The first problem of hiring too fast is fairly obvious. You wind up spending money too quickly. For most Internet startups payroll is the biggest fixed expense and it is far easier to hire than to fire, which winds up being a problem if raising money turns out to be harder than expected. But there are also more subtle problems with hiring too fast. In particular, companies that hire too fast tend to do so by dropping their quality standards which means they wind up with teams that are not as effective as they could be. Even worse is when companies hire too fast by not paying attention to company culture or hiring “mercenaries.” Teams built that way tend to have a poor work environment with high turnover show very little resilience when encountering a speed bump.
But what about hiring too slow? At first glance that seems like it would cause fewer problems. But for startups that have fast growing services not building up their teams is dangerous. First, customer service or uptime can deteriorate quickly if teams are overwhelmed. And if you fall behind it can take a lot of time to get back on top of things. Second, when organizations go into fire fighting mode strategic thinking gets harder if not impossible. Companies can miss big opportunities if they are just hanging on. Third, solving the hiring problem gets harder the more behind you get because everyone is so busy that taking the time to find and interview candidates seems impossible. Finally, hiring too slow then often flips into hiring too fast as companies over correct.
So how do you find the right pace of hiring? It all starts by being honest with yourself about the growth of your service. If you are overly optimistic you will hire too fast. Conversely if you are growing really fast make sure to take the time to project into the future so you know what scale your team will have to support in six months time. Having a solid hiring plan that’s tied to company growth and revisiting it frequently is critical.
This is the first entry in my Scylla and Charybdis Series of blog posts. In case you missed the introduction, the idea is that startups are hard because you can always err both by doing too little of something but also by doing too much of it. Since I don’t have a lot of time to write this morning, I am picking a particularly easy one: raising money.
If you raise too little money the bad consequences are fairly obvious. In the worst case you run out of money altogether and have to shut down. But even when it’s not a fatal outcome, you may wind up spending too much time fundraising again soon and more importantly you may be underspending relative to the opportunity. That might create an opening for a competitor to come in and you wind up building a smaller company than you otherwise could have.
But what are the failure modes when you raise too much money? Money has a funny way of “spending itself.” Initially you wind up hiring just a bit too fast and those hires then hire a bit too fast themselves and pretty sure the organization as a whole is growing too fast. And you will be undisciplined in other areas as well from excessive marketing spend to feature creep (or delaying launch). Put differently, there is a declining marginal benefit of money raised — eg $10 million doesn’t get you twice as far as $5 million. Often it will get you barely any further and sometimes the bad consequences will be so sever that you never ship or ship an awful product that falls completely flat because it is hyped but fails to deliver (can you spell Color?).
There are to other important failure modes that come from raising too much money: turning down what would have been a good exit and having to endure a down round. Generally entrepreneurs get seduced into raising too much money because they see pre-money valuations going up with the size of the raise and so each dollar raised seems less dilutive. But that doesn’t properly capture the opportunity cost of carrying a higher valuation. The higher the post-money valuation the less optionality exists with regard to exits and future financing. If you are familiar with option pricing you know that it essentially amounts to adding up values across many future paths. By having a high post money you more or less eliminate the paths that have an exit or a financing at lower valuations. That doesn’t show up anywhere on paper but if you were calculating optionality, cutting out paths reduces the value of an option.
So the challenge for the entrepreneur is to for each financing to find the Goldilocks amount to raise. How do you do that? There is a lot of detail to be filled in but the basic principle is simple: be realistic about your revenue/usage and expense growth and raise for give or take 18 months.