The problem with drip-feeding funding to internal startups
Venture-backed startups usually receive venture capital investment via one-off investment rounds. The company then has “runway”, measured in months or years, based on the expected burn rate, until they’ll run out of money or need to raise another round of investment.
Runway tends to be a powerful forcing function, pushing the CEO to spend thoughtfully and plot a route to the milestones they expect to achieve by the time they need to raise more money.
Runway is also freeing for the CEO: they have money-in-the-bank, to spend as they see fit. Even if things go badly, they know how long they have remaining based on the current burn rate, and can take corrective action or extend their runway by cutting costs or focusing on revenue.
It’s also a vote of confidence in the CEO by their investors, who demonstrate belief in the CEO’s vision and ability to execute during a time period which could be measured in years.
Internal startups usually receive investment in a quite different way. They are often ‘drip-fed’ funding month-by-month. Any significant increase in monthly spend must be approved by managers or stakeholders from the mothership. The CEO is disempowered by the knowledge their company’s funding is potentially up-for-debate. Every. Single. Month.
The CEO’s freedom to operate or plan for the long-term is substantially reduced, knowing that the interests and motivations of those who control the money are not necessarily aligned with the CEO’s and the startup. The CEO may feel obliged to skew decision-making towards appeasing mothership-imposed supervisors or quasi-Board Members month-to-month, rather than what they believe is in the long-term interests of the company.
The effective loss of agency can be harmful and self-perpetuating. With funds drip-fed, and a CEO who needs implicit (or explicit) monthly approval, the mothership gets a more hands-on role, and participates in day-to-day affairs more than would or should otherwise be the case.
Operating defensively
It can also lead to a defensive operating model whereby the CEO is disincentivised to take operational decisions which require the mothership to increase monthly spending. The danger in asking for more money is:
The mothership starts reviewing existing spend, looking for ways that it can be cut in order to reduce the marginal monthly increase. And/or…
Increases the degree of scrutiny on the CEO’s decisions, leading to greater interference from the mothership
By operating defensively, the CEO focuses on averting the loss of what he/she already has, rather than taking potentially risky decisions to drive growth.
This can get worse when the gap between the mothership’s early enthusiasm for a concept and their longer-term intolerance for an absence of revenue, starts to bite.
It is easy for the mothership to pledge support for the internal startup at the beginning. The mothership might agree that revenue will be negligible for, say, 18 months. It gets harder when, 12 months later, with some turnover in the supervisory board or investment committee, pressure mounts on the CEO to deliver early and/or cut spending.
This problem is compounded if the mothership is funding multiple internal startups in parallel, and the investment committee is unfamiliar with or not convinced by the pattern of venture returns following a power law. If some of the internal startups are failing, and especially if they’re failing egregiously, the investment committee may start to measure the success of their portfolio as an average, rather than assessing each individually. When that happens, the failure of one startup may make the committee more restrictive towards the others.
