Innovation occurs when startups stay hungry for funds—but not too hungry, and not for too long.
That investment sweet spot can be the difference between creativity and complacency, finds a new study coauthored by Harvard Business School Assistant Professor Maria Roche. Her research offers insights for founders and early-stage investors about how much funding tech startups need to produce desired results, and when it’s best to bestow them with it.
Based on financial and technology data from thousands of early-stage tech firms, “Too Much, Too Soon? Early Funding, Technological Unconventionality, and Innovation Capabilities” finds that funding limits encourage startup founders to tinker and experiment more. However, the uniqueness of the technology a startup develops noticeably declines after firms receive larger sums of first funding—sometimes called series A—after initial bootstrapped funding.
“Throwing money at the problem is not always the solution,” says Roche. “In fact, having some resource constraints can encourage more deliberate, experimental behavior. When the goal is innovation, constraints can serve as a productive forcing mechanism. Timing matters. Delaying initial funding may allow firms to develop foundational capabilities that serve them better in the long run.”
Roche cowrote the working paper with Harsh Ketkar, an assistant professor at the McCombs School of Business at the University of Texas at Austin. In an uncertain economic and political climate, the study suggests unexpected ways that patience pays off for entrepreneurs and the investors that back them.
When and how much to invest?
Previous studies have produced conflicting results about when and how much to invest in early-stage tech startups.
Waiting too long can starve a young company of resources needed to hire talent and invest in infrastructure that can lead to innovation. Then again, investing too much, too early, can create complacency and a risk-averse atmosphere.
Roche and Ketkar set out to reconcile some of these conflicting reports by focusing on when rather than how much to invest. They analyzed nearly 800,000 observations at 11,853 web-focused software firms founded and funded between 2010 and 2019.
Data obtained from PitchBook allowed authors to track when and how much funding startups received in their early years. Meanwhile, data from BuiltWith allowed authors to observe when founders added or discarded various technologies to their tech stacks, the suite of technologies firms use to develop and run web applications.
What you can tell from a startup’s tech stack
Choosing the right tech stack is a critical decision for startups, which don’t always have a lot of money to buy a full array of expensive software products and other tools. Most startups must work with widely available technological components to build their products—and use them as creatively or uniquely as possible to create a competitive advantage.
The authors then set out to track the “unconventionality” of firms’ early-stage activities—or the uniqueness of a firm’s tech stack compared to the average tech stack for the industry. In other words, the score measures how uniquely the startup combines technologies to build its product, compared with its peer competitors. They also measured startups’ tech “churn,” or how frequently they swap in new tools compared with peers.
The unconventionality scores ranged from 0 to 1, with 1 reflecting the highest level of novelty. The average startup’s score was 0.60 before its first funding round. From there:
The average unconventionality score declined to 0.47 after first funding. This presents a marked drop of over 20 percent.
Startups that waited longer before raising first funding were able to mitigate some of the drop.
In contrast, scores fell even more strongly among startups that raised larger first funding rounds.
“We found that those startups who didn’t receive a lot of money early were trying different things more often,” says Roche. “They were experimenting with what little they had. They were using more unique combinations of technologies within their tech stacks to build their product. They were experimenting more by discarding technologies, then adding technologies. There was more churn, more changes.”
Roche added: “In contrast, those who received lots of money early, there wasn’t as much churn. They could afford to just add technologies. At some point, they have this whole stack and may not know what it's there for.”
Timing funding for maximum innovation
Roche hopes the report will help founders and investors decide when it’s best to fund tech startups—and how much to fund startups—in order to achieve innovative outcomes.
“There’s been a lot of conflicting studies on this subject, with some saying it’s good to get a lot of money early and other saying it’s not good,” she explains. “We addressed this issue and our takeaway is: some resource constraints can actually help build innovative capabilities.”
Two other key lessons:
Venture capitalists and angel investors may consider holding back
“There could be an advantage to waiting a bit on funding, or just not giving as much money at first, so that these startups have to work at creating new routines and new capabilities, something that will help them after they start scaling up,” Roche advises. Investors needn’t push startups to conform as part of the agreement to secure funding.
Patience and resourcefulness can go a long way for founders
All is not lost if funding doesn’t come ASAP, Roche says. “Sometimes it’s better to be patient, to just play around with what’s available before you start getting investments. Don’t get discouraged by delays in funding. In many cases, that breathing room can foster deeper learning and more innovative outcomes. And don’t quit your old job too soon if you think it may take a while to get that first funding,” she says.
Image by Cami Williams for Unsplash.
