Show my startup the money…or not.

26. April 2013 23:46 by Jay Grossman in   //  Tags: , , , ,   //   Comments (0)

Living/working in the New York City area I get to meet quite a few people starting up their own ventures and I am intrigued by how the small, early companies start out. There are all sorts of interesting dynamics to consider:

  • How many founders do they have? If more than one, why?
  • Did they hire employees/interns/partners at the beginning? If so, why?
  • Did they look for outside investment? If so, did they need it?
  • What is their plan for growth/expansion/scale?

Since every business and founder’s perspective are different, there is not a single set of right or wrong answers to these questions. Since most businesses end up in failure, I find 

My informal poll

I informally talked to 50 friends and colleagues about businesses either they have already started or plan/hope to start in the next year. 34 had started businesses and 16 were planning to. While I would not categorize the folks in this sample as representative of the average entrepreneur in America, it resulted in some interesting aggregates (some of them I will share here):

-31 of the 50 had more than one founder. 13 had more than two founders.

-47 of the 50 had no employees (other than the founders). Only one had more than 10 employees.

-26 of the 50 was either looking, planned to look for, or had received outside investment. 

-Of the 34 actual businesses, 7 had invested the time writing an MBA level business plan. Of those 7, only one thought it was a worthwhile use of his/her time.

-Of the 34 actual businesses, 23 had an active revenue model (the business had a possible way to begin earning money) at launch.

There are bunch of other feature variables that would have likely been telling but not appropriate to ask all of these folks – such as the company’s lifespan, revenues, profits, pivots, investments/assets, scope, etc.

While all these variables can certainly have strategic or operational impact on a startup, I am drawn to the finding that slightly more than half of the group desired or perceived the need for outside investment in the very stages to make their business viable. Needing to find outside investment is a pretty serious critical path dependency, especially if need is real. 

Types of business models and their need for investment

I’ve come up with my own categories for business models, each having a varying reliance on capital investment from the beginning.

Ambitious

This type of scenario usually tries to solve big or ambitious problems. They tend for startups to be complex, have many large dependencies, and/or require expensive labor or materials. They simply require large amounts of capital day one to even consider undertaking - like opening a manufacturing facility, construction for a commercial building, or creating a gene research offering.  

Commodity concept requires initial cash

This type of scenario represents trying to implement an established business model or pattern. Examples would be opening up a franchise (like a 7-11 or Dunkin Donuts), starting a restaurant, or opening retail store. Founders will have to have capital day one for things like franchise fees, employees, inventory, insurance, etc.

The grow as you go approach

This type of scenario typically has fewer dependencies and are somewhat less ambitious (at least from the start), so there is not the absolute demand for capital as the other categories. These types of businesses can start small (sometimes as even as a hobby) and be scaled up as sufficient. These may be businesses offering services, selling more flexible products, and/or being able to quickly adapt to markets. I think of examples such as software/web site creators, marketplaces, small vendors, import/export/dropshippers, accountants, doctors,  lawyers, plumbers, and ad agencies.

With the rise of Internet and lower barriers of entry, “grow as you go” scenarios have become popular.  The remainder of this blog post is going to focus on this category.

I estimate that at least 45 of the 50 companies I inquired about fall into this category. While they may not necessarily require large influxes capital day one, many of the entrepreneurs perceived they would need some relatively early on.

Why you shouldn’t take money

David Heinemeier Hansson (creator of Ruby on Rails and 37signals partner) has really strong opinions on why startups should not take outside investment (especially venture capital). He shares some of them in the video below:

 
  • He calls venture capital a time bomb, the most harmful thing you can do to business.  
  • He has not met a single founder who took money that would not have done it differently.
  • Once you take money, you are an addict looking for another round... and you can't piss off your dealer.
  • If you take money, you must either prove your business is viable or the VC owns your company when money runs out 
  • When spending other people's money, you care much less about business. When it is your own money, you want make more it faster.
  • Worst thing for business is to have no constraints, because you don't sense of urgency. Having to spend your own money is most powerful driving force for entrepreneur.

Take the Money

Back in 2008, ShopSavvy released one of the first ten mobile applications in the world and had good success. They were proud to spurn investor offers and stay independent.  They wrote regretted bootstrapping their business detailed in a post named Starving Your Startup. Here are the key takeaways:

  • Taking money from prominent investors is great social proof. It can lead to attracting key Venture Capital firms and top employees
  • More capital you can move faster and hire more/better employees. They discussed how a smaller competitor took money and was bought by eBay – a missed opportunity for them to get acquired and turning eBay into a competitor.

They sum up the post with:

The good news is that by bootstrapping your startup you will have a lot more control and own a lot more of the company at the end of the day. The bad news is that your startup, by definition, will likely be a lot smaller than it could have been with the right investment from the right investors. Even if you end up building that billion dollar business it will have taken you much longer than it might have had you taken outside investment. We spent the last five years turning ShopSavvy into a hundred million dollar company – it is likely we could have done that in a year with the right venture capital partner.

I have been part of both completely bootstrapped and funded startups (via angel investment, not from venture capital). 

My Experience with Funding

In the middle of 2003, my friend D and his friend N were enamored with Friendster, as it was exploding in popularity. D has some serious graphic design chops and N put up the money, so they approached me to build a competing social network that was named Hipstir. This is my first and only experience with a funded startup.

ASP.NET 1.1 was the hot technology and I decided that I was going to use the project to learn it. I spent every minute outside of my day job that Fall building out the site (and nosebleeding through a huge tech learning curve) so we were ready to launch in October.

To give context, MySpace.com had just launched and only had 50,000 members. Friendster was in the millions of members, but then had site outages almost daily trying to support their network structure.

We sent out emails to our friends and all the sudden people started to use the site. Every day we’d see more people sign up people would spam their friends with emails from the site. All of the sudden the site hit a tipping point in the Philippines (of all places), and we were seeing 2,000-5,000 joining every day. I was going crazy every night for weeks trying to keep the site functionality during peak hours (roughly 3am EST).

We had 200K-300K users, so I made the decision that we should have a revenue model since I had spent so much time building/running it but was not getting any monetary reward. The site was doing pretty well with Google Adsense for a few months until Google went public shortly after and drastically reduced its payments for clicks from non US markets. It was too bad, as we eventually got up to 600K users and quite a bit of regular traffic.

I felt like I was pressured into putting in huge efforts to build and run the site. Some of the reason was that I was proud of what I built and was so excited to see all the interest in it. I also felt somewhat compelled to try to make it work longer than I probably should have since N had invested in it. If I had bootstrapped the project, I may not have pulled so many all-nighters and been content with slower (and probably more healthy) growth.

My Experience Bootstrapping

I have mentioned my favorite project a number of times on this blog, SportsCollectors.Net. It was my dream for so many years to build the ultimate community for sports autograph collectors. It drove me to learn about computers and programming, mostly so I could build the site without needing partners/other developers/outside money. So I taught myself what I needed to build it and bootstrapped the project. I very much considered the process of building the site as a hobby at first and it grew to be more with success. 

From 2000-2002, I paid the hosting expenses on shared hosted servers as the site began to grow in popularity. In 2002, I rebuilt the entire site in a different language and began offering subscriptions for premium features. Every year since then, the site sees steady growth and it continues to be a great resource for 1000’s of collectors. 

Since I have no partners or investors, I am in the wonderful position to shape the community. I’ve been able to build some really cool features (exclusive only to this site) that offer value to the site’s members, but may not directly relate to increased revenues. I also am able to enforce policies and remedy issues quickly as I am the sole decision maker.

Conclusions

Personally, I’d prefer to bootstrap a startup if I have the choice. I like the idea for a few reasons: 

  • Founders control all decisions related to the control of company’s direction. I want to own decisions on setting priorities and how to spend money.
  • Trying to raise capital can be a sizable distraction that bootstrapped founders will avoid.
  • Pressure to perform is a good thing. Spending your own money makes the priorities more clear.
  • I get to set my own goals for the company and be beholden to a terms sheet and negotiated timelines. 
  • Partners can offset some of the need for funding if their skills are complimentary.

However, I can see some scenarios where taking some funding could make sense:

  • To accelerate the delivery and execution cycles. TIME IS A REALLY KEY THING. You can always make money or meet people, but you can’t get time or missed opportunity back.
  • There are situations were getting outside help makes sense. If you are building a manufacturing facility, then you’ll probably need millions of dollars that most people don’t have readily available.
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About the author

Jay Grossman

techie / entrepreneur that enjoys:
 1) my kids + awesome wife
 2) building software projects/products
 3) digging for gold in data
 4) rooting for my Boston sports teams:New England PatriotsBoston PatriotsBoston Red SoxBoston CelticsBoston Bruins

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