The secret to a successful startup exit is not what you think

Editor’s Note: Each week Maynard Webb, former CEO of LiveOps and the former COO of eBay, will offer candid, practical, and sometimes surprising advice to entrepreneurs and founders. To submit a question, write to Webb at dearfounder@fastcompany.com.

Q. What are some common threads around investments that have reached a successful exit—and what hasn’t worked? I’m asking to better help founders in my portfolio.

 —Managing Director of a venture fund

Dear Managing Director,

Let me start with where it always ends. It all comes down to cash. If a founder runs out of cash and doesn’t have enough traction to tell a good story that will help get more cash, it will not end well. It’s that simple.

In almost all cases if things didn’t work out, it’s because founders ran out of money. That means that they spent ahead of their traction and didn’t make enough headway to raise more.

When it comes to guiding founders how to spend money, I always offer the same advice: spend money like it’s your own. Now, the truth is that founders are usually so focused on preserving enough cash to stay alive they typically aren’t blowing money. It’s rare to see market rate salaries, let alone fat expense accounts. So, while spending too much isn’t often the problem, spending on the wrong things at the wrong time often is. These are six ways founders miscalculate:

1. Spending too much too early. If there’s not a product yet, founders shouldn’t spend much on anything other than developing the product.
2. Not spending enough. When the flywheel is really going, it might be necessary to spend money on increasing sales and marketing to grow even faster. In other instances, it becomes essential to spend more building the architecture and systems to stay ahead of the growth.
3. Hiring a sales team too early. Having a big sales organization before it’s necessary is a mistake. Salesforce is a great example of a company that did not invest in sales before investing its resources in developing a useful product. That doesn’t mean they weren’t selling—the founders and early employees pitched the service wherever they went, including while waiting in line at the supermarket.
4. Building finance or big HR teams too early. That’s not prudent. Initially, those can—and probably should—be outsourced.
5. Falling for office space. While most entrepreneurs are frugal, many have a blind spot for nice office facilities. The justifications for a hip, well-located space can be tempting—this space will attract employees, and it will impress clients and press. But often the cost simply isn’t worth it, and worse is getting a space that says “We made it!” when that’s not yet true, as it may draw the wrong talent or infuse the culture with a sense of false accomplishment.
6. Paying full salaries. Offering high salaries at an early stage is a surefire way to burn cash. At a startup, everyone should be taking risk, and compensation should be a combination of salary and equity. If the business is successful, the equity will be far more valuable than cash.

All companies that reach a successful exit were able to achieve product market fit (what I call relevance) and get to scale. The only way they were able to do that was through smart money management. There are times when founders need to be frugal and times when they need to fuel growth and capture the market opportunity. Developing the judgment to know which actions to take at which time is where the magic happens.