The “capital invested” trap
July 7, 2009
A lot of startup pitches I see or hear often include a point something along the lines of:
“Over $X million has been invested to date in building our technology/product”
The supposed conclusion, either expressly stated or simply implied, is that by virtue of investing a significant amount of money in development the startup must have a winning product or at least one that would be expensive to replicate.
Whether X is $2M or $20M or more, this conclusion is largely a fallacy. It’s a derivative of the “sunk costs” issue we learn from economics text books. The amount of capital invested in developing a product isn’t necessarily correlated with it’s commercial success or potential. eBay was built on a few hundred thousand in capital and was already breakeven when Benchmark invested. Google has obviously continued to invest heavily in search, but reportedly they never fully exhausted their one and only round of venture funding from Sequoia and Kleiner before reaching profitability. Similarly, just because one startup spent $X million building a product doesn’t mean a smart team of motivated engineers couldn’t build a better version for far less.
Whenever I hear the “capital invested” point about a product, I tend to see it as a red flag. My anecdotal evidence suggests that entrepreneurs who highlight this in their pitches do so to justify company progress which isn’t commensurate with the amount of capital raised to date. Or it’s to suggest a barrier to entry when the company has few other strong competitive advantages.
My suggestion? Focus a pitch on the true metrics of progress and future success of your product or technology. Show potential invesetors why your startup will win over the competitors, whether through product superiority or more cost effective customer acquisition or what have you. Smart investors rarely fall into the “capital invested” trap so it’s not worth emphasizing in a pitch.