When you are an outsider to the Silicon Valley, or to entrepreneurship in general, the news of people and companies investing millions in startups sounds crazy. When that money is poured into companies, too often that money is spent on the wrong things, and that is exactly where the pessimistic feelings come from. Bill Gurley hit it right on the mark when he said,

You also need to know what you should avoid spending your money on. This is the essence of discipline.

The issue with the people (and usually men) behind the startups raising capital is that the discipline is missing and in its place stands ego. What is the current situation? Too many companies burning multiple millions of dollars a month – the Silicon Valley burn rates are a problem.

The Silicon Valley Lifestyle: Greed?

You’ve got to be able to fit the mold and send a message to people that you are winning and that you are on the road to success – even if you are not. I’m not going to bash anyone for acting one way to outsiders, but if it involves burning cash at a high rate, it better at least be for someone influential. The problem is that is not the case in the valley.

Brian Scudamore of 1-800-Got-Junk summed it up perfectly: “I would read magazines, and I would compare myself to other people. I thought, ‘If only I could be like them’”. That is the feeling in the Silicon Valley.

When one company gets a bigger office, so does the next door neighbor. When one company decided to rent out another floor in the building, the neighboring company chooses to move into their own building. Why? It may be greed, although it seems that the source of the issue is ego and social status.

Why do you see corporate social responsibility only at the highest levels? Not only is it a wonderful expense that we all appreciate, but if done correctly it can also lead to growth – positive feelings and actions leads to exposure. Instead of using funds for this or turning $1 into $3, the current atmosphere leads more and more startups to spend money on things with no ROI.

The Effect

Let’s take former New York (very similar atmosphere to SV) based startup Fab.com for example. The company was burning through fourteen million dollars on a monthly basis – before they eventually reached layoffs. Why would a startup spend so much? Their foolish co-founder expected to raise more than the $150 million that they actually raised (they wanted $300 mil).

Today Fab is almost gone and in its place stands Hem out in Germany. It seems that the leaders of Fab that moved to Hem learned at least one thing – you don’t spend $250K on rent each month! Now Hem is spending just $125K for the entire year. No wonder Marc Andreessen went on a Twitter rampage:

“When the market turns, and it will turn, we will find out who has been swimming without trunks on. Many high burn rate companies will VAPORIZE.”

The bottom line is that VC’s and Angels are not doing enough to control the burn rates – if they want to complain about it, they should at least offer a solution. The more we see burn rates increase around unnecessary expenses the more we’ll see young and inexperienced entrepreneurs being turned down by investors, a lose-lose situation in the long run and something that could pop the bubble.

The Fix

Investors need to work with the startups they invest in. No they don’t need to baby sit, and if that is what is needed then the investment was probably a mistake. It is a partnership, and like any partnership each side has his/her share of responsibilities. Maybe we need contracts that stipulate the steps that will be taken before money is spent on non-marketing/development/sales costs. Maybe, the investor should have say in the makeup of the financial managers of the company. The list goes on. The problem is one that will continue until both entrepreneurs and investors work in synchronization to hit the same target.

Photo credit: Liz West