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Hell Yes, You Should Raise VC Funding

(Or, Contra the Wisdom of Crowds)

The “wisdom of crowds” is in favor right now (at least according to the crowds of bloggers and such in the echo chamber).  Fair enough.  Sometimes, crowds can be clearly right.  Think of the masses turned out in support of Dr. King and his nonviolent campaign (though the “wisdom” here is probably the wisdom
of brave individuals):

(Tempted as I am, I’ll hold off from other political examples for now.)

But what about this little gem, hat tip to Paul Kedrosky?  Definitely a crowd. But wisdom?

And I’ll refrain from pointing out many of the less funny, more tragic examples from history, in favor of this nod to RJD and Black Sabbath: “If you listen to fools… THE MOB RULES.”


There is no more common piece of “crowd wisdom” out there today than this little gem: “VC is broken” — or its oft-glimpsed other facets: “startups no longer need VCs,” and “the VC model is irrelevant.”

Well, it’s time to call “bullshit.”  The echo chamber has gotten so loud on this topic that the mob is starting to rule.  The idea is resonating with people, you say?  Well, resonance can bring you a hauntingly beautiful
chorale…


… or it can bring you the Tacoma Narrows Bridge (v 1.0):

So with no further ado, I give you the top ten reasons your startup SHOULD pitch VCs.

Reasons why even pitching, without raising, is useful:

1. An hour with VCs is (or should be) like an hour of free consulting.  For most businesses, getting two Harvard MBAs to sit with you and critique the pros and cons of your business plan is the kind of thing you’d have to pay McKinsey or BCG a boatload of cash for.  But any decent VC meeting should be giving you at least as much valuable feedback as a Porter’s-five-forces or SWOT analysis with a consultant, /plus/ direct intelligence about the market space.

2. An interested VC is like a free retained PR firm.  75% or more of the value of any given VC is based upon his and his firm’s network.  A serious VC will be having conversations in any given month with Wall Street analysts, industy prognosticators, local and national journalists, CTOs, CEOs, CFOs, other VCs, and investment bankers (meaning the guys who buy and sell companies, not the guys who design mortgage-backed securities).  If it’s in your interest that these people know what you’re up to — and it almost always is, at least eventually — then having a VC pumped up about your company is a damn good and
cheap way to get the word out.

3. Pitching builds character.  No, seriously.  Even if some of the VCs you pitch are assholes, well, some of your customers will be, too.  Figuring out how to pitch to assholes (and how to keep your composure without throttling them) is useful.  It’s not more useful than a real sales call — since revenue and profit are much cheaper sources of cash than equity — but it may be almost as useful, since you get to refine and iterate your value prop without burning a valuable customer intro.

Reasons why raising, even without exiting, is useful:

4. A technology coup (e.g., Web site, iPhone app, whatever) does not a business make.  Even if you and your roommate are the most elite of all coding studs, and you put some hugely-trafficked social-whatnot in play with a no-upfront-cost Amazon cloud deployment, you’re eventually going to want to make some money.  And even if your reply is “we’ll just put up some ads,” for example, you’ll soon discover the real money in online ads for a big publisher comes from something called “premium inventory” (as in: not just AdWords).  To sell this “premium inventory,” you’ll need ad sales guys, and eventually ops folks, accounting, and you-name-it — which is all to say, you’ll need to put a business in place behind this groovy Web site of yours. (The same pattern, with different specifics of course, applies to the commercialization of all kinds of technologies.)  Building businesses isn’t rocket surgery, but it’s awful helpful to have experienced brains, some money, and some appropriately-callused hands on your side.

5. If you’re going to pour your life into a startup, you might as well shoot for the stars.  Any conscientious entrepreneur is going to be putting absurd or even borderline insane amounts of time and energy into his startup, whether you’re shooting for bootstrap or big bucks.  If you’re playing in a market that works for VC, why not go for the big bucks, all things being equal?  (If you’re doing a “startup” that’s more about sustainability or a good work/life balance, ignore this point.)

Reasons why raising is useful when an exit event happens:

6. How many times have you sold a company?  (Hint: if the answer is 3 or more, skip two squares and roll again!  Good for you!)  If you’re like most entrepreneurs, the answer is something between zero and 1, inclusive — not exactly a robust data set.  But in the VC world, we don’t get to raise money from our investors until our partners have sold multiple companies, generally both as entrepreneurs/operators and as a result of investing.  Which means that your VC is going to have sold companies, often to some of the same people that might be buying yours.  And the more relevant, comparable experiences you, your team, and your investors have under your collective belts, the better you’re going to be able to court suitors, elicit bids, and eventually strike a deal.

7. When times are good, having deployed VC into your business raises your “price range.”  Plenty of big acquirers would prefer, all things considered, that you bootstrapped the whole thing on your credit cards, never took a dime of equity, leveraged it all with debt to retain maximum ownership, and got to big enough scale to warrant an M&A exit.  After all, in that case, they only have to negotiate with you — a “you” who is leveraged, possibly tapped out, and who may have rational reasons to take a lower price (e.g., the first $20 million is always the hardest, also known as declining marginal utility).  But when you have VCs behind you, you’ve got a good cop/bad cop game you can play. It’s like the salesman who has to take the terms “back to the sales manager,” or like Ulysses tied to the mast: reducing your bargaining freedom can paradoxically get you to better outcomes than you might otherwise have achieved.  (Of course, I realize, when times are not good, this argument is weak or even inverted.)

Reasons why raising is useful even when everything goes to hell:

8. The “orderly wind-down.”  This is a dirty secret that we don’t like to talk about, but everyone inside the industry knows it anyhow.  When you have professional investors on your board, they’re not going to permit a disorderly wind-down.  That means that even when there’s no hope left and it’s costing us time and money, we do our damnedest to make sure a company gets shut down cleanly and legally.  Meaning, the employees get final paychecks, displaced folks get intros to jobs the best we can, the debts get cleaned up as much as possible, and things go according to the “best practice” for the worst-case scenario.  Result?  Lots of scars and woe, but (assuming no fraud or felonies) nobody gets sued.

9. You are written in the VC book of life.  This may seem kind of silly, but it matters to people in this business.  The VentureSource database is the de facto standard that VCs use for business intelligence, and it centers on firms, companies, and people.  Having been a founder or exec at a VC-backed startup puts you in the database, and for better or for worse gives a mark of credibility that folks not yet in the database don’t have.  So, on the (perhaps generous) assumption that you find the other reasons here to be convincing, and you think that being able to raise VC money is a good thing, being written up in the VentureSource database generally makes that easier (you are now a “venture-backed entrepreneur”).  (I understand that this is a little bit circular, like the reason for getting a graduate degree in English Lit — it qualifies you to teach English lit — but the point is, if you want to do it at all, it gets better the second time around.)

And the tenth reason why the anti-VC guys are full of B.S.:

10. The “giving up control” arguments are stale at best.  There might have been a time when entrepreneurs at large didn’t understand the VC game.  But that’s just not true today: the amount of content (good and bad) about VC available on the Web has exploded in the last five years.  You, dear reader, know exactly what’s being asked for (minority ownership, board representation, and protective provisions), and your attorneys and advisors will know exactly where that stands relative to market.  Frankly, professional investors know you know this, too, making overt gamesmanship a pretty unlikely event.  Yes, there are risks — but without significant equity backing, the risk of a dilutive “down round” might instead be the risk of a shutdown.

…but that’s not all!  You also get a bonus reason with extra socio-philosophical speculative sauce:

11. The “bootstrap at all costs” meme ultimately serves concentrated capital at the expense of the bootstrappers.  How so, you demand?  Consider that in a bootstrap-only world, concentrated capital is never fragmented into smaller packages to fund new enterprises.  Instead, it continues to accumulate and concentrate (typically in corporate form), and the risk of new enterprise creation is pushed onto individuals — intrepid, willful, but ultimately resource-constrained and over-leveraged individuals.  All of the risk of the economy’s only true wealth-creating (as opposed to redistributing) engine, invention, is pushed out onto those individual bootstrappers.  The level of personal risk and capital required of entrepreneurs in this world tends to discourage and slow the overall pace of invention and competition.

Happily, this is not the world we inhabit: instead, we have an institutionalized way to recycle capital from its gargantuan silos, a means for taking the risk that could be ruinous to an individual and divvying it up among the pools of concentrated capital.  We call that institution VC, and it exists because of the fear and greed sparked in the minds of the stewards of capital by the breathtaking riches (and disruption) that new inventions cause every so often.  The jungle law of economic competition here has created an epiphenomenon that causes accumulated capital — otherwise the very center of inertia for the status quo — to plant the seeds of its own Schumpeterian demise!  Viewed this way — and I’ll admit it’s a stretch — benefiting from the VC system (in any of the ways I mention above) is actually the most awesomely “guerilla” of all startup tactics.

And so, dear reader, I implore you, like Chuck D and Wyclef before me have done: don’t believe the hype.  VC is alive and well, and hell yes you should raise VC for your startup.

Randall Lucas is a VC and blogs at Blog.rlucas.net.

About Nathan Kaiser

Comments

  1. Andrew Korf says:

    Thanks for this post – VC is a word many of us early stage folks don’t even consider, but you make the case for keeping VC as an option.

  2. Hero says:

    (1) Free consulting from VCs is often negative and can erode morale, better avoided for young companies. Its not as if the founders do not know the negative sides themselves. They need someone to give solutions to the problems that they can foresee, something VCs are not likely to do
    (2) Free PR, but uncontrolled too. Very likely to give out more information to outsiders than you wish to disclose outside closed door meetings
    (3) In early days, you are less likely to meet the VC partners and more likely will get to deal with junior execs at VC firms… who in all likely hood are going to be assholes – worth avoiding just to keep the negativity away

  3. Allen Morgan says:

    This is a very interesting, well-produced post (that YouTube dance video is terrific!). I disagree with most of the assertions the author makes, but it’s a very nuanced, cases-specific area in which advice is helpful (e.g., a consumer-facing website operates within a set of constraints and opportunities much different than a startup building bio-diesel plants or large solar energy arrays.

    This broad, extremely important topic is the subject of a set of posts that I’m drafting over the next couple of months. For my intro to the topic:

    http://allensblog.typepad.com/allensblog/2009/08/financing-innovation-introduction-to-the-series.html.

    I look forward to a constructive discussion.

  4. Our pseudonymous Hero’s #2, above, is a legitimate point. The PR thing is uncontrolled. The truth is, with very, very few exceptions, there is dramatically more danger from people /not/ knowing about your startup than from the inverse. Still, some things are confidential, and I can only share from personal experience: I’ve never forwarded an entrepreneur’s pitch deck outside of the firm without permission, and I have always respected explicit requests to keep a lid on specific deals, features, numbers, etc. that come up in a presentation.

    Allen Morgan suggests things are different in capital intensive energy projects. Surely that is so. But I have no idea how you could do a startup energy generation facility /without/ private equity capital (lke VC).

  5. Victor says:

    Hate to be blunt, this piece is more or less meaningless. Its like saying one needs a lawyer to go to court. What is more important to the individual is a good lawyer, or in this case a good VC. Unfortunately VCs as a group has had a lousy record as investors, so if one is follow down the path and speak in generalities, we can say entrepreneurs will have a no better chance than a coin flip to make the venture a success when dealing with a VC. This added to the fact that a lot VCs are narcissistic a**holes don’t help.

    Randall also tried to skirt the issue of control. The most important aspect of a startup is control and ownership. Once that is given away, the entrepreneur is nothing more than a wage slave. I highly recommand all entrepreneurs read Felix Dennis (the guy who started Microwarehouse, Computer Shopper, Maxim and others) book, “How to Get Rich”.

    What a VC like Randall should do is to put hard performance numbers on paper to back up to the idea why one should work with his firm. Don’t try to defend the whole industry, it is a lost cause. What say you Randall? How has Voyager done? Care to share the numbers?

  6. Control and Performance. Hmm.

    “Control” is a complete red herring as a purported negative aspect of VC funding. Take a look at a debt instrument (e.g. a bank term loan) and you’ll see /real/ control: a senior, perfected lien on all your assets, plus MAC clause etc. Get in bad with your senior debtholder and you’ll learn what “control” really is. VC influence is soft by comparison: board representation and minority ownership %. This is really cap structure 101, folks.

    “Performance” is always an interesting point. Picking a VC to work with based on the industry’s (or a firm’s) financial returns is like picking a doctor based on the medical industry’s (or his hospital’s) average return-on-equity. Strongly relevant only if you are an asset-allocating institutional investor. (Arguably, an entrepreneur shouldn’t even care about returns to those investors, only those to himself and current shareholders.) The real question for the entrepreneur is, can I generate better returns for ME by having this particular VC involved (the old “50% of a lot vs. 100% of a little” question).

  7. victor says:

    Control is not red herring, easy for you to brush it off when you are the one who is in control! Comparing to banks is fair game, but who said an entrepreneur has to get funding from either a bank or a VC? How about from customers? Friends and family and so on. Fact is, as a VC, you don’t have all the control even for your own fund! The institutions dictate the life cycle of the fund, and in return dictate the action of a VC. A VC is in constant race against the clock to exit, regardless it is the right time for the startup to do so or not. Control is everything.

    Performance is highly relevant when it speaks to the caliber of the VC an entrepreneur is about to work with. It speaks directly about whether the VC can help the entrepreneur a success or not, and it is also a good way to have the sanity check whether the entrepreneur’s idea is valid or not. If you are trying to sell the idea that a VC is a great source of PR, mentoring, and so on, and the said VC has a lousy record (which is a reflection of their judgement, or one would think), why would an entrepreneur want to waste time with the VC? Its the blind leading the blind. Just take a look around town in Seattle, just how many VC firm is willing to publish their records or lack there of?

    Bottom line is, VC as an investment class is a creature of the technology bull market that lasted for a few decades. It was at the right place at the right time, but the structure problem of this investment vehicle both for institutional investors and entrepreneurs is causing it to implode. Unless there is a structure change, no amount of glossing over will do. Perhaps it is time for many of the people in this sector to switch careers.

  8. Been away from this post for a while, but wanted to make a brief response on what appears to be a couple of misconceptions about the fundamental structural stuff at play with VCs.

    First, my post was about entrepreneurs and why they should raise VC. Polemical, directed, one-sided. That’s the idea. (There’s a shed-load of anti-VC spew out there already.)

    On control and funding sources: raising any kind of investor capital means yielding some control. But your VC on his own has embarrassingly little “control,” given this big bad reputation; again, this is minority shareholding and usually one out of five board seats.

    (Plus, it’s generally contractually impossible for us to control / operate the companies. We’re generally banned from it by our own investor agreements.)

    On performance: think about this for just a minute. The money that flows to the investors (VC “performance”) is money that’s not flowing to the founders. Yes, its possible and desirable to align interests and seek win-win. But VC “performance” per se is emphatically /not/ what a rational founder is seeking.

    (Plus, it’s generally contractually impossible and illegal for us to publicly disclose “performance” numbers. Seriously, go read the Securities Act.)

    Please all — do continue to look critically at the VC world and push on the weak spots (like too many boards per partner, or fund life constraints). But don’t get bogged down in the irrelevant or ill-informed negativity.

  9. Ashok says:

    All the criteria outlined by Randall are attractive to the novice entrepreneur not the seasoned ones who could actually make the VC’s investments successful if they listened more to seasoned entrepreneurs. VC’s want to be in control since they think it is their money that makes the venture. Seasoned entrepreneurs know that it is they who will deliver the success and money is not the most important component. That is today’s conundrum.

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