Should young tech companies seek venture capital, or try to bootstrap their way to profitability? It’s a hot topic these days, especially with the economy and funding climate the way they are. I’ve been asking experienced entrepreneurs around town for their opinions on bootstrapping versus venture capital and angel investment, after I read a recent blog post by Hillel Cooperman of Jackson Fish Market, a bootstrapped Web startup in Seattle.
One caveat: these entrepreneurs were self-selected for not taking VC money in the early stages of their companies. So what they say is not necessarily representative of the innovation community. I’d also like to follow up with thoughts from venture capitalists and VC-backed startups, so please comment below or contact me directly. That being said, here are a few highlights from what I’ve heard back, before diving into the details in a separate post.
— “One of the biggest pitfalls [for] an entrepreneur…is to seek validation from the venture community,” says Christian Chabot of Tableau Software, who bootstrapped his startup for a year and a half before raising venture capital in 2004 and again in August 2008. He adds, “If you’re going the venture route too early, you can count on selling 1/3 to 2/3 of your company.”
— “It hasn’t made sense to us to date to take VC money,” says Steve McCracken of CultureMob, who has gone the bootstrapping and angel routes. “The best return for us on investment is probably a smaller investment. Every buck you take, the exit has to go up that much higher for everyone to get a high return.” He adds, “If you look at the successful businesses, I don’t think there’s a clear correlation with amount of early capital investment.”
— “We typically operate with six employees, yet we have traffic that compares with local VC funded sites that have more than 10 times that number of employees,” says Josh Petersen of the Robot Co-op, which was originally funded by Amazon. “And I’m pretty sure we are more profitable than any local Web startup because of our approach.”
Cooperman helped start the whole discussion on his blog a couple weeks ago. “In our observation, a significant percentage (I think the majority) of companies that are funded by VCs today would be better off as bootstraps,” he wrote. “I believe when a company that can bootstrap takes VC, it can warp their values, and ultimately may lower their chances at success…We’re in a world right now where bootstrapping is the exception (in our industry), and VC is the norm. I think that should be inverted.”
Tony Wright, co-founder of Seattle-based RescueTime, responded to the post with a different view. “Taking outside funding is just trading equity (usually 15-30 percent) for the ability to focus, getting a reliable paycheck, and be able to move at the velocity you want to move,” he wrote in a comment. “Of course, I totally agree with you if taking funding results in the founders giving up control of the board. But for a company that gets funding when they have a bit of traction (increasingly the norm), they generally don’t have to settle for giving up control of their company.”
Cooperman replied, “I think venture capital is a great tool for business where it makes sense. My main issue is that I believe, for the bulk of tech startups today that take it, it’s inappropriate. It’s less about the control issues, and more about the expectations…You may agree that anything less than a 10x return (the typical VC goal) is a failure. And that’s great. But what happens if you take VC, you shoot for that 10x return, and then find out there’s only a 3x return. Now you’re at the crossroads. The VC will push you to do all sorts of things to try and get to 10x. (As they should given their business model.) You may have concluded that not only will the business never produce 10x returns, but trying to morph it into a 10x business will kill your 3x creation. To the VC, 3x and a dead startup are essentially the same given the way they calculate their batting averages. At this point you have a problem.”
I contacted Cooperman, and he declined to name any companies he thinks have taken too much cash. But he told me, “In general, I think most consumer Web startups, unless they have to produce something physical, or buy some type of machinery, or have some unusual technological infrastructure need (indexing the Web for example), or have to upend some huge player in an established market, should always operate at the barest minimum they can.”
[For more comments from the Seattle entrepreneurs, stay tuned for Part 2—Eds.]
