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Venture Capital and the Modern Startup – Building a Company is a Team Sport August 28, 2008

Posted by John in social media, Technology.
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A post today called Fuck the VCs caught my attention. I’ve been a full time entrepreneurs for over 10 years now and have tons of experience with VCs.  Heck alot of my friends are VCs – “not that there is anything wrong wit that”.

The fact is that VCs have lost their abiity to do early stage deals at scale. My good friend Scott Rafer makes a great point – their behavior is more around the market. VCs are institutional investors – they aren’t a hands on mgt consulting firm. Some firms act like they are mgt consulting firms and that they know better than the founders – stay away from those. My advice on VC firms is to stay away from partners that can’t remember what was discussed at the last board meeting. Then unilaterally run the company from the board. VCs playing entrepreneur is not their job. So stay away from those.

My advice for entrepreneurs is try to own >51% of your company for as long as you can. Scott Rafer had a strong  comment on the F VCs post – Scott says..  “This is good advice packaged but packaged in a terribly destructive way. I certainly try and design my startups to work well on bootstrapping or angel money, delaying institutional VC indefinitely. That MO tends to be much better for founder equity and employee returns, user-responsive product design, growing at a speed that is good for the company, etc.

On the other hand, WTF? Take a cold shower or something. The level of anger being displayed here has no place in this discussion or this community. Every market segment has its bad actors, both at the individual and corporate granularities. VC doesn’t have a greater share of bad actors than the ecommerce or gaming sectors. Large-scale, software VC is simply a formerly great business in decline, and there are a lot of good, smart people who haven’t made in VC yet who are worried about their (and their families’) economic futures. It’s not evil — it’s their job and they may not feel they can switch. This is a group of very smart people who are fighting for ever-fewer capital-intensive deals, and it’s getting ugly. Their economics are clear, and the bigger the fund the worse the problem.

Fred Wilson’s been publishing a good series of posts on VC economics. In the latest one [link below], he inadvertently outs one of the main problems with running a VC-backed startup. When your business is doing well, the VCs have have every incentive to push you to take more money you may not need — it’s the only way they can be as profitable as they need to be. Fred’s got a relatively small fund, great empathy with entrepreneurs, and is near the top of the heap for any number of reasons. However, he has that same problem — the interests of the Common Stock held by the founders/employees and the interests of the Preferred Stock held by the VCs is divergent in many, many more cases than the Conventional Wisdom suggests. It’s the reason why the VC asked about 100 iPhone apps, et al.

http://www.avc.com/a_vc/2008/08/venture-fund–3.html

The software VCs are in a different business than we are, but one that is largely dependent on us. It’s a business that used to overlap with ours heavily but where the overlap is decreasing more quickly than capital could ever leave the sector. That leads to market consolidation, market share fights, and VCs requesting startups perform unnatural acts — all of which are ugly, and none of which are evil…

As Scott points out that might be through a series b round. My goals for companies is to bootstrap them to own at least 51% after a b-round. The only way to do that is to bootstrap the seed portion to increase the early value. Then taking money on the business and founders terms makes sense.

VCs are not the problem it’s more of the market. Building companies is a team sport and in some cases you need VCs on the team – some cases you don’t.

Scott Rafer has it correct above – certainly try and design my startups to work well on bootstrapping or angel money, delaying institutional VC indefinitely. That MO tends to be much better for founder equity and employee returns, user-responsive product design, growing at a speed that is good for the company, etc.

Building a company is a team sport and sometimes VCs are on the team  – and there is nothing wrong with taht – just pick the right guys/gals.  When you don’t pick the right teammates everything goes south.

Comments»

1. Denny K Miu - August 28, 2008

John, I agree with your post. Please allow me to put forward some simple economics from an entrepreneur’s perspective. Typical engineer makes $120K a year (it could be as much as $180K but rarely less than $80K). At that rate, we need $3M in the bank to make up for our annual income (at 4% interest using FDIC-insured CD’s). No one could save $50K a year after tax, but even if we could, it would take 60 years to save $3M. In other words, if you need to draw a salary and you need to work for a living, you can never achieve financial independence. Starting your own company is all about achieving financial independence (especially if this is going to be your first success). If you need to build a semiconductor fab or if you need to hire an outside firm to code the next ASIC, then you need R&D money and you need lots of it. No one would give you that kind of money except the VC’s. But if you need money to pay salaries for a bunch of engineers, then there is a better way. You can do a lot if you could convince four to six engineers to focus and work together for two years. And if you could convince them to do that without pay (it is not easy but I did it for my last startup), then you don’t need VC money. In two years, you should be ready to ship and start to build revenues, and you would still own 15% to 25% of the company (each). Then all you need to do to get your $3M is to sell the company for $15M which is very do-able if you have a real business. Like you, I would never have the gut to write a post with that title. But “F$^5 the VC’s” is pretty accurate.

2. John Furrier - August 28, 2008

Wow that is a great example Denny and a great lesson to entrepreneurs especially in this low cap acquisition market. Who knows those 2-4 engineers could be the next Intel, HP, Apple, or Google.

Great lesson

3. Alex - August 28, 2008

Something that we’ve talked about before John is to only accept VC money at the right valuation. Accepting VC money at the wrong point can overdilute your startup and all but ruin any chance of big money later.

I agree wholehearted that picking the right people is the single most important thing in running a startup. Titles and tasklists are less important, the “right” people will be able to excel while wearing a multitude of hats. And maybe most importantly, they’ll think like you. They’ll share your goals and vision and work just as hard as you to make them a reality.

4. Lisa - August 28, 2008

@Denny. There are a couple of problems with your example.

You forgot the sale of your two year old startup is a windfall capital gain that will push you in the top federal and state tax brackets. So a Silicon Valley based engineer would have to pay about 1.35 million of the 3 million she received from the sale in taxes.

You would really need to sell the startup for about $30 million to achieve the financial independence you described.

I also found the statement “sell the company for $15M which is very do-able.” pretty naive. I would guess it is less than one in four thousand chance a two year old startup would be sold for 15 million and even less of a chance to be sold for 30 million.

Where did I get this number? Well, a VC expects only one in ten of their portfolio companies to make a significant amount of money, and about half to break even, and about half to fail. VC’s reject two to three hundred companies for each company that they add to their portfolio. The liquidity event generally occurs in two to five years.

May I suggest a less risky approach. Keep your 120 thousand dollar a year job and invest all of your earnings for two years in publicly traded companies. 240 thousand dollar invested in several small cap stocks is much more likely to get you closer to financial independence and you would still have a job if things don’t work out.

5. Denny K Miu - August 28, 2008

@Lisa – I agree that it is very difficult to flip a company in two years and that is not my experience. My experience is that it takes at least two years to have a product ready for market and be in a position to generate revenues. Then it is at least another eighteen months before enough profit is generated to cover expenses and pay everyone market salaries. But two years is the minimum commitment if anyone wants to take the bootstrapping path. By the way, you always have a job if things don’t work out. And that’s the point.

6. John Furrier - August 29, 2008

If you can’t quit your job then you’re not an entrepreneur. Sometimes and most of the time you see entrepreneurs moonlight to give themselves time. At some point the entrepreneurial team has to pull the proverbial rip cord and go for it. It’s scary but VC is not a saftey blanket. VC is a business. Institutional investors are not emotional investors – it either works or it doesn’t. Unlike entrepreneurs and angels – it’s personal. Only take VC when you need the capital and you’re thinking that you can make a boatload of benjamins.

7. John Furrier - August 29, 2008

Comments from YCombinator Aggregator ——

5 points by peanutcruncher 5 hours ago | link

The first thing anyone looking for venture capital needs to understand is that the primary objective of a VC company is to turn every dollar they invest into your idea into $10 over a 2 to 5 year time frame.

Once this fact is understood and understood well, then many of the emotional issues just sort of go away.

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4 points by ryanwaggoner 7 hours ago | link

I disagree with the premise that anger towards VCs isn’t warranted. The author paints a picture of the VC as an innocent victim of changing times:

“VC doesn’t have a greater share of bad actors than the ecommerce or gaming sectors. Large-scale, software VC is simply a formerly great business in decline, and there are a lot of good, smart people who haven’t made in VC yet who are worried about their (and their families’) economic futures. It’s not evil — it’s their job and they may not feel they can switch.”

Those poor VCs who have no other career options available to them, and must therefore resort to squeezing every last drop of blood from entrepreneurs who don’t know any better.

I absolutely believe that there are some fantastic VCs out there, but anger against the industry is only natural when you’ve been screwed over like some of these companies have.

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16 points by dennykmiu 7 hours ago | link

Being angry with VC’s is like being angry with mother-in-law. They will always be a pain if you insist on sleeping with their daughters. So make your choice, stop taking their money and they will cease to be your problem. Be angry … but move on.

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1 point by tonystubblebine 6 hours ago | link

I love this analogy.

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2 points by dhouston 2 hours ago | link

http://www.joelonsoftware.com/articles/fog0000000056.html

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1 point by dennykmiu 2 hours ago | link

This is the best article ever for explaining the two possible startup models, bootstrapping and venture-funding. I have done both, one that was funded by VC’s and failed and one that was bootstrapped and succeeded. I would be the first one to admit that I have limited data points. Thanks for sharing.

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2 points by shimon 2 hours ago | link

There are some good things in this post, but did anyone else get the impression that the author ran parts of it through a Markov Chain text generator to bulk it up?

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2 points by Hexstream 5 hours ago | link

I’ve always wondered, do you really have as much decision power with 51% of the company as 100%?

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3 points by iuguy 5 hours ago | link

In theory, yes. Having said that, leverage can be achieved through means beyond shareholdings and it’s worth remembering that if you’re heavily dependent on your VC for assistance.

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1 point by gaius 4 hours ago | link

Nope: http://waxy.org/random/arsdigita/

Having said that, it’s not at all clear what Greenspun really wanted VC money for in his cash-generative services company. Perhaps he shouldn’t have bitten off more than he could swallow.

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1 point by mechanical_fish 2 hours ago | link

it’s not at all clear what Greenspun really wanted VC money for in his cash-generative services company

Read his new, improved, more nuanced explanation in Founders at Work.

If I were to summarize his answer: It requires intestinal fortitude to embrace slow, organic growth at the cost of turning down lots and lots of business from a market that is begging for your services. But it is also hard to recruit people to grow your company — especially businesspeople — in a bubble economy where every company with a domain name is going public with billion-dollar valuations. So ArsDigita tried to come up with a plan to go public, and that inevitably involved VCs, because back then investment banks didn’t bother talking to privately funded companies, because the fix was in: Why bother working with actual, profitable companies when you can make more money by scratching a VC’s back? It’s not like the market was paying attention to fundamentals at the time.

The moral of this story is that bubbles suck. They’re completely disorienting: The market value of everything is screwed up, and you’re surrounded by irrational people. I do not miss those days at all.

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-1 points by ahold 7 hours ago | link

fuck’em

8. Lisa - August 29, 2008

@Denny. A two year gap on a CV with the job description founder of a failed startup will require some explaining during an interview if you get one.

To a hiring manager, starting a business doesn’t mean your an entrepreneur, it just means you quit or you were sacked from your previous job.

A couple of startup gaps and your CV will be rejected outright unless you have a personal recommendation.

9. John Furrier - August 29, 2008

Lisa,
That is why no one is hiring me :-) I have a few spots on my resume.

Judy Estrin who is one person who has experience building technology and businesses weights in with this quote. “Taking risks and failing is one of the most critical aspects of innovation.”

http://bits.blogs.nytimes.com/2008/08/28/does-silicon-valley-face-an-innovation-crisis/

That being said I agree that doing a startup isn’t for everyone.

10. Is Y Combinator the University of Internet Startups? - September 3, 2008

[...] Casasanta of Taptaptap simply entitled “Fuck the VCs.” Responses from Hacker News and John Furrier, among others, led to a lot of heated debate over the role and significance of venture [...]

11. Is Y Combinator the University of Internet Startups?  »TechAddress - September 3, 2008

[...] Casasanta of Taptaptap simply entitled “Fuck the VCs.” Responses from Hacker News and John Furrier, among others, led to a lot of heated debate over the role and significance of venture [...]

12. TabUp Makes Tab Sharing Elegant  »TechAddress - September 3, 2008

[...] Casasanta of Taptaptap simply entitled “Fuck the VCs.” Responses from Hacker News and John Furrier, among others, led to a lot of heated debate over the role and significance of venture [...]

13. Gino F - September 4, 2008

OK great points here. I have a 7 year old web based application that was boot-strapped and the 3 principles who own 100% of the stock worked for almost 3 years without compensation [thank goodness for MasterCard & home equity loans]. Current revenue is in excess of $700,000 with a pre-tax profit of 12-15%, no debt and a huge market that only has 2 other players. This has been achieved with only one salesman. We recently added anther sales guy. Just approached by a company to purchase us and their offer was one year annual revenue..yikes! paid out as follows:
1/3rd cash, 1/3 stock in the new company/ 1/3 paid over 3 years when 15% growth is achieved each year. Their goal is to take their $100MM company public within 24 months. In their estimation our business has the potential to do $100M plus domestically but can also transfer off shore. One final note the two other players in the space were VC funded and the latest one received $1.5 and the other $12M. We are committed to grow the company and willing to continue to grow it organically…but before we tells these guys to get lost does anyone have any comments on what might be a reasonable valuation/counter offer based on the facts as listed here?

14. Gloom in Ventureland - Try Gloom Period - Innovation Happens Now « Furrier.org - Business & Technology Blog - October 15, 2008

[...] Good companies win and bad companies [...]

15. New Reality: Silicon Valley Wealth Machine - The Rebooting Meritocracy « Furrier.org - Business & Technology Blog - December 19, 2008

[...] of wealth is upon us. The entrepreneurs and investors that move on this opportunity will capture the proverbial “chips on the table”. As an entrepreneur, I love this market – opportunities are everywhere. Unlike the dot com bust, [...]

16. Broadband Developments - Unified Communications, Virtualization, Security, and Web 2.0 » New Reality: Silicon Valley Wealth Machine - The Rebooting Meritocracy - December 22, 2008

[...] of wealth is upon us. The entrepreneurs and investors that move on this current market opportunity will capture the proverbial “chips on the table”. As an entrepreneur, I love this market. Opportunities are everywhere. Unlike the dot com bust, [...]

17. Silicon Valley in Trouble? I Don’t Think So - A New Model Will Arrive « SiliconAngle - February 22, 2009

[...] of wealth is upon us. The entrepreneurs and investors that move on this current market opportunity will capture the proverbial “chips on the table”. As an entrepreneur, I love this market. Opportunities are everywhere. Unlike the dot com bust, [...]

18. Silicon Valley in Trouble? I Don’t Think So - A New Model Will Arrive « The SiliconANGLE - May 19, 2009

[...] of wealth is upon us. The entrepreneurs and investors that move on this current market opportunity will capture the proverbial “chips on the table”. As an entrepreneur, I love this market. Opportunities are everywhere. Unlike the dot com bust, [...]

19. Semiconductor Entrepreneur - July 7, 2009

All of you losers in the internet space are pussies if you can’t self-finance because your capital requirements are so low. Moreover, you have no fucking idea how VCs operate. Their portfolios are loaded with high-tech and capital intensive deals and then they throw scraps at you stupid internet assholes to fight over for a year or two and see if it goes anywhere. Wake up. And don’t think you’re clairvoyant in your stupid business pursuits. You are the dregs of private investment.

20. Michael Barber - November 30, 2011

VC firms are just a way for the rich people to stay richer and the poor people to stay poor. VC firms wait for an entrepreneur to start an idea they can copy and go public with and put the little guy out of business. It’s a scam. As someone said earlier, take your hard earned money and take HALF the risk in the the stock market and you are likely to get x10 fold your money back because your playing the same game the VC guy is at that point and you beat him at his own game. Now you are real VC, take more risk and pick and choose winners based on the formula of “copying” a good idea and implement with a real and full “business and development team”.


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