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I had lunch with an old friend recently who does Angel investing.  As sometimes happens, I launched into our lunchtime discussion with a bit of controversy by suggesting that I wasn’t too sure what the value of Angel was for many companies.  After a bit of calibration on where I was coming from, we quickly converged to agreement.  Any company that takes Angel is on the road to being a VC funded company.  Companies that are never going to be good VC opportunities therefore shouldn’t take Angel.   Angel is not really a “VC-Lite” substitute, its more “VC-Seed”.  This post isn’t really about Angels, it’s about the interplay of Capital, Startup Ideas, and Entrepreneurs.  To succeed, you have to understand how to balance all three along one of the successful paths.  Leaving the path will very likely make your venture unsuccessful for lack of capital.

The VC World has gone through a fascinating transition over time.  I’ve done 5 startups now, and not one of them could’ve started up in the way they did today.  The reason is that with few exceptions, it’s no longer possible to get funded with a slideshow and a team.  Ironically, as VC’s were deciding that its much cheaper to start companies, they apparently decided that this makes it possible for companies to start themselves via bootstrapping.  Yes, there are seeds and super-seeds, but even these typically require a product and some semblance of customers to get funded.  Talking to entrepreneurs, it’s also not clear that the equity dilution and the terms offered them are better than the old days.  In many ways they are worse, because they’re very tilted towards forcing a VC’s preferred outcome:  creation of at least $1 billion in value.

What are the ramifications of all this for entrepreneurs?  

The VC Utility Curve:  You’d Better Have a Billion Dollar Idea

First, I am not one of those who wants to argue that VC is bad and should be avoided at all cost.  There are plenty of them out there, but so far as I can tell, no more now than there ever were.  I’ve made a lot of money working with VC’s, I understand how that world works, and I frankly don’t have a problem with it.

Keep in mind the VC’s are in business to deliver a return to their Investors.  They’re going to conduct that business in whatever way they need to in order to deliver that result, just as any entrepreneur will do what it takes to keep their startup alive and hopefully thriving.  In their world, the VC’s get a few very large returns and a lot of no return at all.  The big ones furnish the overall return and offset the failures of the others.  What this means is that entrepreneurs can often experience a difference in goals and utility curves.  For those that slept through the economics classes in college (actually, I found it pretty boring myself), a utility curve shows your willingness to accept risk in exchange for potential rewards.  For the entrepreneur, this means keeping in mind that their VC’s are willing to accept a lot of risk for an extremely large reward.  Sounds like the entrepreneur’s ideal, right?  Well let’s assume that the reward is selling a company for over $40M just 10 months after its founding.  Let’s further suggest that there are VC’s who will look at that and decide that well it is truly life changing money for the founders, it just isn’t interesting to them.  They would want to keep playing the hand.  BTW, if your investors are ready to bail at an early stage, it likely means they think something is about to go badly for you, not that they think it is a great price. 

Okay, so let’s get beyond VC motivations (make sure you understand that Utility Curve thingey and pack it away in the back of your brain!), and talk about companies.  Let’s just assume that the practical ramification of the Utility Curve idea is that unless your idea can be a Billion Dollar idea (he says in best imitation of Dr Evil), you’re not VC material.  And if you’re not VC material, you’re also not Angel material.  The latter have all the same issues that lead to their own Utility Curve problems, they just don’t have as deep a pockets or a name brand firm, so they get involved earlier in order to have a place at the table.  After all, Venture Returns are not great historically, but to this day they’re not so terrible relative to the stock market. 

Mind you, the Angel will be much more tempted by the early acquisition exit, but until that presents itself, you need to operate like they are helping you down the road to getting VC.

Okay, one more nuance for entrepreneurs.  In the old days (geez, I hate saying that, but 5 startups later, I’ve got some war stories), VC’s used to sort opportunities into features, products, and markets.  Time was, they wanted to invest in markets much more than products, and never in features.  Sounds funny to think of something a company builds as a feature, but there are many startups that have built features.  The problem is that whatever they are a feature of may wake up one day and decide they want to own that market.  VC’s that ignored the rule learned, much to their chagrin, that despite great traction, when a company like Twitter starts to take the reins of its ecosystem, a few “feature companies” lose their value very suddenly.

Think of the feature-product-market hierarchy as another way of seeking the Billion Dollar Idea.  Hard for a feature to be worth a Billion, perhaps even impossible.   Easier for a Product, but still not a lay-up.   Uncovering an entirely new Market, though, is usually worth a Billion.  Part of the Entrepreneur’s task is therefore to look at what they’ve got very objectively and figure out how to make it a Market.  Never mind that you initially built a Feature.  Can you apply that Feature to making a Market in some way?  Why is your Big Idea not just an add-on to someone else’s Big Market and Big Product Suite?

To some extent it is a game.  All things can be bought.  Larry Ellison doesn’t worry that Oracle isn’t far along on SaaS because he can buy every public SaaS company without too much trouble.  So the other thing is not to be too dogmatic about the definitions.  Markets turn into Products, and Products into Features if you don’t move fast enough.  That’s called Consolidation.  VC’s view Consolidation as inevitable.  Your job is not to talk them out of it, it is to convince them why you have the most valuable gem in the Consolidation Crown, and perhaps even why you’ll be the one doing the Consolidation first.  At the least, convince them why your idea is a Must Buy because there can be no alternatives.

Bootstrapping:  When You Don’t Have a Billion Dollar Idea

To a lot of entrepreneurs who have a Good Idea (notice I didn’t say a Big Idea), and just want to get on with it, the description I’ve given of the VC funded world sounds pretty scary.  There’s a big agenda there and a lot of the bullet points weren’t even things the entrepreneur wanted to deal with.  That’s okay.  As one very successful VC told me, a lot of companies shouldn’t go for VC.  Sometimes we lose perspective in Silicon Valley.  Everything is not Venture Capital funded.  In fact, the vast majority of small business gets by without a dime of VC.  So again, ask yourself whether you really have the next Google-sized Big Idea, or whether you’re more comfortable with your very Good Idea.

A Boostrapped Good Idea goes something like this.  You get together with 2 or 3 other people (the number usually seems to be about that many).  You work for a year to build your product.  During this time you starve, either for money, because you aren’t getting paid, or for time, because you are doing it after hours while your Day Job feeds your family.  You really can’t afford to starve for more than that year, so that puts some boundaries around what you can tackle.  At the end of the year, the idea has to be immediately monetizable.  You’ll spend the second year also starving, while you tune up your marketing, get the word out, and possible correct flaws in the product.  By the end of the second year, if all goes well, you’re ready to quit your Day Job and never look back.   There is actually a long list of companies that have followed exactly this plan and wound up very happy about it.

Speaking of happy bootstrapping, Valley peeps often refer to these Good Ideas as “Lifestyle Businesses.”  They say it like it’s a Bad Thing.  What’s the worst that can happen with a “Lifestyle Business.”  You work really hard for substandard pay and ultimately fail.  Wait.  That happens in VC deals too.  Hmmm.  What’s a happy scenario?  You work really hard and build up your business until it is doing $20M a year and doubling each year with 12 employees.   You own 100% of it, you have no debt or equity out (except to partners and employees who are in the same boat as you), you’re the master of your destiny, and you are loving life.  $20M a year goes long way with 12 employees.  So don’t say, “Lifestyle Business” like it’s a Bad Thing.  It could be the best thing that ever happened to you.  OTOH, that’s still not Jet Money, so if you absolutely positively must have that Gulfstream, you better get back to looking for a Big Idea.

There Really is No Middle Ground

Here is the other strange thing about this brave new startup world: there really is no Middle Ground.  Not only could none of the startups I’ve been in get funded the way they did back in the day, many of them were just not Big Ideas.  There is a vast gulf between your $20M very-happy-thank-you-very-much bootstrap and the Billion Dollar Big Idea.  I can point to all sorts of interesting software companies that made it to maybe $100 million in revenues, but that are in that vast middle ground.  It turns out that those are untenable ideas in the current climate.  That’s not good enough, and if you get a chance to build such a company, it will be because the investors thought it was a much Bigger Idea.  You will be surprised to find out they think you fell short, even though you may even have gone public.  Don’t ask me how I know.

So ignore the Middle Ground.  Don’t try to put lipstick on that pig and sell it as a Big Idea.  Make sure you at least think you really do have a Big Idea.  Otherwise, Bootstrap a Good Idea.

All Roads Lead to the Bootstrappa’s Paradise

In the end, starting a company these days is a Bootstrappa’s Paradise.   If you are a Bootstrapper, you will have never seen a better alignment of forces in your favor:

–  Software is cheaper to build.

–  Subscription models are alive and well, and an annuity is a much happier thing to bet your Boostrappa’s time on than a few big checks followed by crickets chirping.

–  It isn’t just software that is cheaper.  If your audience is online, you can reach them with less cost and effort than ever before.

–  People who are not Bootstrappers can’t get capital to compete with you nearly as easily.   They have to at least find a few token Bootstrappers to build a product and line up customers.

–  People with VC have to avoid the niches.  Those are not Billion Dollar Big Ideas.  But niches are a happy place for a pure Bootstrapper.  Niches exist all the way up to $1 Billion and are there for the taking, if you have what it takes.

–  If you do have a Big Idea, you can get it to the stage where it is fundable much more easily than those who can’t bootstrap.  Time was a successful exec from a Big Company with a name and a slide show could land a big VC check and go after your market without ever having to starve.  I won’t say that no longer happens, but it is a whole lot less common.

–  If you have a Good Idea, very interesting businesses are being built today.  Take a look at companies like 37Signals, SmugMug, and Atlassian.  The latter grew all the way to $60M, at which point VC realized it really was a Big Idea, and Accel made the biggest investment they’ve ever made to get in.

Not everyone can be a Bootstrapper.  Some days I wonder how long the Bootstrappa’s Paradise will last, because its hard on the deal flow for VC’s.  I read with interest a RWWeb post suggesting that start-ups created by people out of work are at an all time low.  The numbers are pretty startling.   Out of curiosity, I took the liberty of superimposing VC returns against the dip:

It’s interesting that the return spike follows almost exactly the right lag after company founding.  Yes, Virginia, portfolios are a beautiful thing, and when you’re betting on the Billion Dollar Plus end of the utility curve, they benefit from having a lot more bets available to choose from.  Meanwhile, despite a lot more unemployed, a lot fewer of them are choosing to start businesses.  

Bootstrappers:  start now with little competition, and (hopefully) with a rising economy for some tailwind.  I’ll be doing a series of posts on Boostrapping because, it’s a Bootstrappa’s Paradise. 

Related Articles

Hey, don’t take my word that it’s hard to raise money on a slideshow.  Fred Wilson pretty much says so on his blog too.

Chris Selland wonders whether it isn’t time for investors to target the Middle Ground in some way.  I agree, and hate the thought of leaving it fallow.  But until they do, entrepreneurs need to understand the rules of the game to win.

Bootstrappa’s Resources

Links to the Bootstrappa’s Paradise blog series as well as other useful resources for Bootstrappers.