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Dear startups: Don't treat money like toilet paper

Startups, no matter how much money they've raised, should only spend capital on the things they absolutely need and should save the rest for a rainy day.

Toilet paper is disposable. Money is not. Chris Matyszczyk/CNET

Having lots of money isn't a reason to spend it, especially if you're a startup that has yet to prove itself as a viable, sustainable business.

There have been a lot of early-stage startups raising monster rounds in recent months. Ark ($4.2 million seed), Viddy ($30 million), and Gumroad ($7 million) are just a few prominent examples.

The funding party may be over though, at least according to Paul Graham, a prominent investor and founder of Y Combinator.

"Jessica and I had dinner recently with a prominent investor," Graham said in a letter to Y Combinator's portfolio companies, referring to his wife and Y Combinator co-founder, Jessica Livingston. The investor "seemed sure the bad performance of the Facebook IPO will hurt the funding market for earlier stage startups. But no one knows yet how much. Possibly only a little. Possibly a lot, if it becomes a vicious circle."

Graham's warning was quickly picked up by the major tech blogs, and many journalists compared it to the infamous R.I.P. Good Times presentation that Sequoia gave its portfolio companies in 2008.

On the surface, it seems like Graham is delivering a grim warning about the bubble bursting in Silicon Valley. I doubt that was the purpose of the letter, though. His goal with the letter was much simpler; its purpose was to get his portfolio companies to lower their burn and become more careful with their money.

It's the last paragraph of his letter that is the most important:

"The startups that really get hosed are going to be the ones that have easy money built into the structure of their company: the ones that raise a lot on easy terms, and are then led thereby to spend a lot, and to pay little attention to profitability. That kind of startup gets destroyed when markets tighten up. So don't be that startup. If you've raised a lot, don't spend it; not merely for the obvious reason that you'll run out faster, but because it will turn you into the wrong sort of company to thrive in bad times."

It doesn't matter whether you're a bootstrapped startup or a hot company with $35 million in funding -- acting as if the money in your bank account is all you're going to get will make your company leaner, more efficient, and less prone to market crashes.

If you have a cash-rich startup, don't treat your money like toilet paper. A market crash (have you seen Europe lately?) or a botched redesign (have you seen Digg lately?) can quickly suck all the oxygen out of the room.