Disconnect: the startup funding money game is counterproductive

Disconnect is a weekly column in which Tech in Asia’s Charlie Custer pokes at holes, plays devil’s advocate, or otherwise attempts to rain on the tech industry’s parade.

This has been a crazy week for fundraising, even by China’s standards. If you’ve spent the week under a rock (or perhaps a mountain of work), let me catch you up quickly: Chinese daily deals company Meituan-Dianping raised a US$3.3 billion funding round, breaking the record for the highest-ever non-IPO funding round that had been set by Didi Kuaidi last year in its US$3 billion round.

There’s no getting around it: $3.3 billion is an absurd amount of money. To put it in perspective, that’s more than the total GDP of the Maldives (and a bunch of other countries). Meituan literally raised more than an entire nation’s economy. That’s straight-up crazy. And so is the startup scene’s attitude towards fundraising in general.

It all boils down to a pretty simple fallacy: more is better. If a company raises $5 million, it must be better than a company that raised $1 million, because five is more than one. If a company raised $50 million, then its competitors had better raise at least $60 million, because they need to raise more than 50. Obviously, not everyone in the industry subscribes to this idiotic philosophy, but if you’re reading this I bet you know people who talk that way. And to be honest, we are all – myself included – sometimes taken in and misled by the sheer numbers some companies are raising.

Of course, there are a couple problems with this. First, the idea that more equals better is bullshit. A company that raises $10 million isn’t necessarily any better, stronger, or even more valuable than a competing company that raises $5 million. Perhaps it needed to raise a larger sum because its business is less efficient and its burn rate is higher. Or perhaps it’s just better at finding cooperative investors – a valuable skill, to be sure, but not one that necessarily predicts the ultimate value of your business.

How many founders would trade some of their equity to make their company look good to their peers?

Second, the more-is-better fallacy actually encourages bullshit, too. Another reason our hypothetical competing startup might choose to raise $10 million is just to make itself look better. And of course, if you don’t really need the money, why even raise the money at all? You can just say you raised a $10 million round when you really raised less. That happens plenty in Asia’s startup circles. I wrote last year about a number of Chinese companies who lied about previous rounds and ultimately got found out when they IPOed in the US and were forced to publicly reveal the real numbers.

But there’s no real punishment for doing that, and to be honest, most people aren’t going to care much that some startup lied about its series B round two years later when it’s about to IPO. So in an atmosphere where people act like companies that raise more are better companies, why not lie about your funding, or at least round the numbers up a little bit?

The result of all this, of course, can be a runaway game of one-upmanship, where one company after another raises (or claims to have raised) more than it actually needs in a kind of marketing effort. Investment funding costs you equity, though. How many startup founders would want to trade some of their equity for marketing that makes their company look good only amongst their peers in the tech industry? I’m guessing almost none. But that’s basically what you’re doing when you raise a round that’s higher than what your company actually needs. (Not to mention putting your company at risk of the ever-dreaded down round).

This, then, is my plea for sanity. Let’s all try to be a little less impressed by the big splashes of cash. A startup that can hit its targets and grow its business smoothly with a small funding round should be more impressive to all of us than some behemoth that raises billions, burns money like it’s going out of style, and then (often) ultimately nosedives.