Still smarting from our experiences with the dot-com boom and bust, web 2.0 entrepreneurs have taken a very cautious approach to raising money for their startups. The modus operandi these days is to self-fund pre-launch and raise money after certain amount of traction. In the dot-com days, if you showed up at the VC firm with a power point and a team of engineers you are already miles ahead of the lone MBA from Stanford GSB pitching a vague idea at random conferences. Given all the money and careers (VC & entrepreneur) lost to the dot-com bust, it seemed like a better idea at first glance to validate the business model and/or product concept before raising a ton of venture capital. For 80% of startups this actually the smarter strategy, however, for a select few, the crossing between launch and user traction will often become the “valley of death.”

Chung Cheong, my rowmate at eBay, calls it simply, “Sell the Dream or Sell Results” but nothing in between. The valuation of a venture follow a the same “J Curve” in which the value of a PORTFOLIO of investments by VC’s typically bottoms out for the first few years of the fund’s lifecycle before hitting the hockey stick, reaching parity, and eventually the positive return territory. Startups are very much the same way. Your startup could potentially be worth MORE at the concept stage than at the development stage. Put it in an another way, the moment the product launches, your company could actually be WORTH LESS than when you only have your business plan.

Why you ask? Its because once you launch you product publicly, VC’s can take a wait and see approach to evaluating your company. No longer do they have to bet on their own intuition and the founding team; instead, they can simply look at your acquisition metrics to determine whether the concept is sound. Given the wait and see attitude, less VC’s will be willing to jump in and lead a round, forcing valuation decreases. Before product launch you can sell VC’s on your dream, vision, funding team, your ability to sell ice to the eskimos, and your ability to charm multiple VC’s into a bidding war; after launch, all VC’s want to see is metrics. Of course, if you gain traction your startup will be worth more than the valuation you could get at concept stage, but its a risk you take.

Looking around I see a lot of examples, lala.com raised and ton of money pre-launch. TagWorld was similar. And ofcourse, Riya raised money before launching its beta program. Yet Techcrunch has tons of struggling startups launching and waiting for traction that could not sell themselves off for 500K.

The worst part is if the startup does not have a viral acquisition model (say some sort of web2.0 e-tailer), in that case, the only way to scale is to invest in marketing. But without venture investment, there are no marketing dollars to be spent. Thus the death spiral of a great product/company could simply be because it didnt raise enough money to give the idea a proper chance of survival. A product that is extremely viral has less need to raise significant money before launch because it does not need money to gain critical mass. Also, if there is a lot of competition in the space with little differentiation (even if their is a viral user acquisition) money could become the deciding factor to winning (or better yet, ditch the idea in the first place).

So look deeply at your startup and your user acquisition model, a head long rush to get the product out the door might not be the best thing to do as far as raising venture capital is concerned.