Thursday, July 29, 2010

3 (Sometimes) Stupid Reasons to Raise Venture Funding

I have had 3 entrepreneurs speak with me about their fund raising strategy in the last 3 weeks, and I realize that the once great art of bootstrapping a startup (i.e. building a business on cash flow rather then venture money) has been lost.

All 3 of these entrepreneurs had the opportunity to grow their companies off of cash flow alone.  And while in many cases it makes sense to raise money to accelerate growth (e.g. you have product market fit and want to ramp like crazy to beat your competitors, build network effects, hire a crapload of sales people, etc.), these entrepreneurs’ reasons seemed way off to me:

Some reasons the entrepreneurs said they wanted to raise money:
  • “Everyone is doing it”.  I spoke with one YC team that really wanted to raise money from a VC.  When I pushed on the reasoning, it was purely for bragging rights with their YC classmates.  I found this verging on ridiculous.  You want to give up a big chunk of your company so you could tell your friends about how you raised money?
  • “To get expertise”.  VCs can often provide great advice, discipline, and rigor to a startup.  However, there may be alternative approaches to tapping in to that expertise.  E.g. rather then sell 25% of your company in a seed round, why not find a few very qualified advisors or a board member?   Even if you give them 1-2% each you end up giving away much less of your company.
  • “I want to burn the boats”.  The thinking here is that a venture round would force the entrepreneur to shoot for the home run.  While entrepreneurs should always think big, sometimes the venture round locks you into a big exit that you may never reach.  E.g. a friend of mine started a company that was generating about $1 million a month in revenue.  They ended up raising a round instead of bootstrapping the startup (after they were cash flow positive).  This led them to (a) grow big and hire lots and lots of people = higher burn  (b) has prevented them from selling the company when they could have gotten the best exit (c) and my friend is now sitting in monthly board meetings charting and recharting company strategies with no exit in site (the business topped out at $20 million a year in revenue).  If he had not raised money he and his co founders could probably have pulled $10-$20 million each out of the company in cash by now and moved on to the next thing.  I don't think his current business has an obvious path to get bigger, and he is locked in.
There are many legitimate reasons to raise venture or angel money.  However, if you have a cash based business (rather then an equity business) in which you are throwing off more cash then needed for growth, you might want to think twice about what a venture round brings you and whether it is worth just bootstrapping your company.

By the way, some companies that largely grew off of their own cash flow:
  • Microsoft (grew largely off of cash, then raised a round with TVI late in their life)
  • Bloomberg (raised some money from an investment bank well after it was profitable)
  • Coupons, Inc (doing supposedly close to $1 billion in topline revenue)
  • GroupOn (raised from NEA to do something different, the pivoted and raised money largely for founder liquidity and advice)
Know of any other startups that bootstrapped their way to success?  List them in the comments please :)


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