Why Startups Benefit When Big Investments Come Later
Summary.
When startups receive funding can have as big an impact on innovation as how much funding they get, according to researchers Harsh Ketkar of the University of Texas at Austin and Maria Roche of Harvard Business School. Using data from theBefore the Color Labs photo-sharing app was launched, in 2011, its developers raised $41 million from Sequoia Capital, Silicon Valley Bank, Bain Capital, and other investors—an extraordinary amount for a startup that hadn’t even released a product. In less than a year, the app surpassed one million downloads on Apple’s App Store. But its success was short-lived. Users began complaining about Color Labs’ lack of features, technical problems, and poor user experience. But, rather than tweaking the app to address those issues, Color Labs remained focused on signing up more users. Usage plummeted. By December 2012—and with $25 million of funding capital still unspent—Color Labs’ investors and board members voted to cease operations.
Where did Color Labs go wrong? Most analysts concluded that its massive early funding worked against it, creating pressure for the company to scale up quickly instead of refining the product. To put it another way, Color Labs shifted too quickly from experimentation to exploitation—and its large early investment probably played a major part in that.
The company’s failure illustrates that when startups receive funding can have as big an impact on innovation as how much funding they get does. Some research has shown that financial constraints can benefit startups by forcing them to be scrappy and resourceful. But other studies on the effects of startup capital have gotten conflicting results, and researchers don’t fully understand exactly how or why the timing and size of first investments influence a venture’s subsequent moves.
When Harsh Ketkar of the University of Texas at Austin’s McCombs School of Business and Maria Roche of Harvard Business School decided to study this issue, they opted to focus specifically on how early funding affected firms’ ability to develop unique technical innovations. “We wanted to conduct this research because we were always baffled by prior studies that said being constrained is actually very good for startups,” says Roche. “How can not having a lot of cash be a good thing?”
Using data from the market research firm PitchBook and the data analytics company BuiltWith, Ketkar and Roche recorded information on 11,853 U.S. tech companies (most of which were creating apps and websites) founded from 2010 to 2019. First they identified when each company’s earliest funding arrived and how big the round was. Then they set out to analyze how those factors influenced subsequent innovation.
To measure how innovative companies were, the researchers looked at how unconventional the combinations of technologies used to make each startup’s product were compared with those of other firms in its industry. For instance, a firm using Microsoft Azure (a cloud provider), Amazon RDS (a relational database), and Tableau (data visualization software)—components of a popular tech stack—would be considered more conventional and less innovative than a firm combining lesser-known products such as DigitalOcean, CockroachDB, and Metabase. The researchers say companies using more-novel technology combinations tend to create more-innovative and -functional products. Previous research had measured innovation using metrics such as patent filings, but because filing a patent is a cumbersome process and many startups never seek patent protection, the ways firms combine technologies is a more relevant measure, the researchers say, noting that breakthrough products such as the iPhone came about primarily from combining existing technologies in novel ways.
The researchers drew several conclusions from their analysis. First, the later that startups receive their first round of funding, the more likely they are to keep experimenting after the money arrives. Second, startups that receive a bigger investment use more technologies after cashing the check but combine them in less unusual ways, signaling reduced experimentation. Last, the track record of the investors (including whether they exited past investments through IPOs or acquisitions by other firms) affects how much companies continue experimenting after launch, and the timing and size of the first investment can impact how long a startup survives.
“Although earlier (and/or higher) availability of funding may ease survival pangs during a firm’s infancy, it also may diminish the need to experiment and search for technological combinations that constitute an innovative product,” the researchers write. “This situation also may preclude firms from developing innovation-oriented capabilities early in their lifecycle and thereby stymie later innovation as well.”
Roche recommends that entrepreneurs who build products using technology ask the following questions before taking on a new investor:
Does the investor share your appetite for experimentation?
Startups that wait, or are forced to wait, to accept funding aren’t constrained by investor oversight and the need for immediate success, Roche says. They can test and pivot without having to prove viability or growth potential. Experimentation then becomes part of the company’s DNA, which ultimately propels firms to be more innovative. “Firms that don’t accept early funding can afford to wait and experiment until they find the innovation that separates them from the competition,” Roche says.
Roche recommends finding an investor who values experimentation and tolerates risk as much as you do. Early investment from large institutions that demand immediate or short-term financial results will likely cease or limit experimentation.
Is there a strategic fit?
Roche advises startups to consider the investor’s preferred exit strategy, whether it be acquisition, IPO, or allowing the startup to keep growing as a profitable, stand-alone company. The investor’s ultimate goals can significantly impact the startup’s growth trajectory and operational decisions. Investors seeking a near-term IPO are more likely to push for quicker results over constant experimentation.
Startups should also consider how hands-on investors will be. Do they want to select the technology you use? Or are they content to provide strategic guidance? How innovative your company becomes is ultimately dependent on how open it is to change. Micromanaging investors can close firms off to it.
Has the investor helped other innovative startups?
Roche advises entrepreneurs to think about a potential investor’s reputation, capabilities, and possible influence on the company’s direction. Experienced tech investors have probably worked with resource-constrained startups that must balance growth against innovation. They are more likely to encourage experimentation and scrappiness than first-time investors or investors who don’t have experience with technology companies.
“The experience and approach of investors can significantly impact a startup’s ability to remain flexible, innovative, and unconventional, even when they receive large amounts of funding,” says Roche. “Who you allow to invest in your company is a strategic decision that can stop innovation in its tracks.”
About the research: “Combining for Unconventionality: When Resource Constraints May Promote Innovation Capabilities,” by Harsh Ketkar and Maria Roche (working paper, 2025)
“A Large Investor Would Have Cut Their Losses”
