This subject annoys me to no end. It seems to pervade the startup ecosystem, dominate media coverage over funding, and be the focus of far, far too many entrepreneurs’ discussions. The topic is funding size, or more specifically, the association with funding size and level of success of a startup. In this post, I’d like to take a swing at all the “Did you hear So-and-So raised $70M? Man, they are killing it. I hope I can get there someday,” comments I’ve heard and try to challenge those in the ecosystem to decouple their mental association with achievement and round.
First off, I get it. We live in America. We uphold things that are bigger, stronger, taller, faster, flashier, or all-in-all have more general badassery than the last thing. We are fascinated by things which dwarf our own interactions and experiences – whether that is in nature, sports, or business, and media coverage capitalizes on that fact. Generally in our society, bigger is better.
I’m not arguing that CEO’s shouldn’t pay attention to funding rounds. Quite the opposite – it is absolutely critical to be constantly aware of the marketplace, and to be cognizant of the ever dynamic sandbox we are all playing in. Being aware of funding is so important because it heavily shapes one’s view of the market. In order for the economics of VC-investing to work, there is an inherent assumption that the asset you are infusing with capital will grow to multiple times its size in a short time period. If a VC jams $30-50M in a growth round, it speaks volumes to what some very smart people think about a given opportunity, the unit metrics surrounding the business, and their ideas on the space. Sometimes it spurs other VCs to back their competitors. Furthermore, if it is in the same space as your startup, it sends tremors throughout the vertical. Generally speaking, the size of the round equates to the size of the stone being thrown into the pond… and if those rocks are big enough, the ripples the splash sends out can turn into full-blown waves very quickly. It creates potential opportunities, induces the occasional heart-attacks, and causes late-night strategy sessions.
No, what I’m attacking is the “If I could just get funding, then we could….” mentality. I can’t count the number of conversations I’ve had with entrepreneurs where it seems like their strategic plan ends with getting VC-funded. That’s it. They’re “made” men/women as soon as pen hits paper.
Yes, funding usually indicates that a business is doing very well. A quick succession of rounds indicates that a startup is piling on customers, or boasting egregiously high LTV/customer acquisition ratios. Being backed by a VC is a giant stamp of approval.
But the emphasis is being put on the wrong thing. It’s not the round. It’s the success which has caused the round. It’s customers. It’s margin. It’s market share.
We have a natural tendency to mentally correlate the steps in the funding lifecycle of a startup with a hierarchical view of success. Since only a small fraction of companies ever receive angel funding, let alone VC, or growth rounds, it’s easy to link the level of difficulty of acquiring the capital to comparable tiers of achievement. Having been on both sides of the table myself, I’m not trying to take away from the accomplishment of entrepreneurs who have raised capital (in fact, it’s usually a process that is a black hole of time and energy), but rather say that the victory isn’t the access to the capital, it’s what you do with it.
Unless you are building very specific things – bio, cleantech, or high-tech companies with a capital “H”, you don’t need it. In fact, the greatest entrepreneurial stories usually have recurring motifs of: entrepreneur is dirt poor, finds a way to be especially scrappy, and overcomes tremendous odds. Look at Kenneth Cole with his fake movie, or the Airbnb guys with Obama O’s, or Fred Smith of Fedex putting payroll on a roulette wheel. In fact, those stories of triumph occur with the explicit lack of capital.
I honestly feel one of the worst/scariest things that can happen to entrepreneurs is to receive egregious amounts of capital very early on in cycle of founding their company. I want to vomit when I hear a first-time CEO tell me that they got $400k from their rich uncle to start their “revolutionary” social network startup. Cash doesn’t force them to get down to the basics of their product. Hell, you don’t even have to find co-founders when you can just hire people outright. When you don’t have money, you have no choice but to focus on only the most essential components of your business. You figure out product/market fit, and you keep iterating. It’s just too damn tempting to develop something without proving out the worth of the product.
“Yeah, but then I could get paid.” Okay. There is a statement that is closer to the truth.
Early startups are tough – and when you see credit card debt racking up, you start to feel the visceral pinch of financial hardship very quickly. Funding allows entrepreneurs to take salaries. It provides stability. As you stare across the mountain of bills on your desk, having completely forgotten what the taste of steak is like, to see a news clip of a peer who just got funding and bumped their salaries to $100k, it can seem like it is the most important/critical thing in the world. Yet, I would argue you shouldn’t be taking anything more than bare minimum salaries ($0k, $20k, $30k) until you get to a product you can bring to the market place and see early sales/adoption with. Besides, even if you never raise VC, you can easily have a shot at doing better than that peer monetarily over the long run.
“Wait, what? Jon, c’mon. If you sell a company for $200M you’re doing way better than if you weren’t able to get the round.”
Yes and no. It depends by what criteria you are judging “better.” Those people who are at the helms of the big, hot companies are on a ride of their lives. People like Brian Chesky with AirBnb are being showered by press, treated like demigods in the startup community, and are forging new markets out of thin air. They are positively impacting thousands of people every day. The scale is immense.
But if you are referring only to the average monetary gain for the founding entrepreneur, I’d say it depends. An entrepreneur who bootstrapped their whole business could easily be in a better financial position than the CEO of a company that sells for $100M. They will rarely have the same scale, but the monetary gain can easily be matched by non-VC backed startups.
Let’s look at two examples:
VC Company Inc. is a high tech company that raises a number of rounds of funding over 5 years. After the initial friends and family money, the angel round, the Series A round, and two more rounds of VC funding, the CEO has an ownership of 4% of the company. They are doing $20M a year in gross revenue, and hit break-even by late year 3. An acquirer comes along, sees the growth potential, and buys it for $100M at year 5. The CEO had been making $150k a year for five years and then walks away with $4M (4% * $100M) at exit, for a total of $4.75M total compensation.
Bootstrap, Inc. is a newly formed ecommerce business, and grows sales to $1.5M a year after two years, eventually selling the company after five years. The CEO hires three people to do most of the processing, but retains 100% equity of the company. The four person company is humming along, but doesn’t grow beyond $1.5M in revenue. Since there are no new capital expenditures, the CEO takes a dividend of $0.5M a year for the last three years of the business. She eventually sells it for $4.5M, for a total compensation of $6M.
Clearly these are two examples I made up to support my own hypothesis, but they are certainly not unheard of. My point is that bigger isn’t *always* better for the entrepreneur. Bootstrapped & cash cow business aren’t always the sexiest, but they can produce great products and fantastic livelihoods for their entrepreneurs. If you think the only way to hit your payday is to be at the helm of a hot, VC-startup, think again (not that you should be doing a startup for solely that reason, but that’s a different topic).
My – perhaps overly drawn-out – point is this: Funding is NOT the end-all, be all.
There are hundreds of different types of businesses. Some are right for outside investment from angels and VC’s. In the right contexts, VC funding can add incredibly important fuel to a startup. It can help companies grow orders of magnitude faster – but with all that said, it isn’t appropriate for most, even in high tech. They simply have no need for it. It doesn’t mean the VC company is better because they have to jump through hoops to get the funding. It doesn’t mean they make more money, and it sure as hell doesn’t mean they will be more successful.
So, please stop putting the emphasis on The Almighty Round and the $200k salaries.
Focus on the important stuff: your customers, your product, and your team. The rest will come.
