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The Series A Crunch: One More Reason to Bootstrap and Skip Venture Capital

Posted by Bob Warfield on November 29, 2012

I’ve talked a lot about bootstrapping on this blog–I am a total convert, and I’m enjoying every minute of bootstrapping my own company.  There are many reasons for my enthusiasm.  Investors these days are going to make you take most of the bootstrap journey before giving you a dime being one of the biggest.  You’ve got to build a product, you’ve got to get customers, and you even have to show some kind of decent momentum.  No more raising money on a slideshow idea and a team.  No more just build a cool product and get money.  You really do have to go quite a ways on your own nickel.

Yes, there’s a little bit of seed money to be had, but what are you really getting for that?  What is that transaction all about?

In the end, it’s about getting very meager wages in exchange for handing over a lot of equity and control to some strangers you’ve just met.  Are you really that concerned about a job?  Should you really be calling yourself an entrepreneur if you are?

I like the 37Signals take on the whole bootstrap thing.  They simply ran a consulting business to pay the bills and agreed amongst themselves they would each contribute 10 hours a week to their startup and they’d make sure it was a solid 10 hours.  By following that journey they produced not only the Basecamp product but Ruby on Rails as well.  Yeah sure, not everyone is as brilliant, but that’s not bad for having paid the bills through consulting.  Why do you need to raise capital again?

Whatever your thoughts on needing the capital, Sarah Lacy delivers one more crushing reason to find another way:  the Series A Crunch.

Folks have been talking about the coming Series A Crunch for a long time.  There simply is not enough later stage VC to support all the thousands of seed companies that have been started.  Lacy says that people she’s talked to suggest only about 20% of those seed companies will get another round.  And trust me, not a heck of a lot more will get the Series B after that.  There’s never enough money for the next stage simply because that’s how the plan works.  The plan is to provide as little capital as possible, get as much control as possible, cut off anyone who doesn’t produce phenomenal results, and then double down on a the very few that are left.  Rinse and repeat until you get to IPO’s.  Growth less than 2x a year is not tolerated.  3X is about right and more is better.  You will be stack ranked against the other deals the investors have seen constantly.

Mike Maples says that every year there are 10 awesome companies created.  John Collaghan of True Ventures says there are about 2000 companies a year getting seed money.  Let’s run the numbers.  For a Consumer Internet play, we’re talking perhaps 5 years and for an Enterprise SaaS play let’s use 7 years.  Further, let’s say we raise enough for 18 months each time.  This is an easy problem to set up in Excel, but I will save you the trouble.  To go from 2000 to 10 in 5 years means 4 18 month rounds and only 17% of companies are getting funded each round–that’s pretty close to the 20% Lacy quotes.  To go from 2000 to 10 in 7 years means only 35% are getting funded.  I’m not surprised, it’s easier to show steady progress in an Enterprise SaaS deal whereas Consumer Internet is more of a hits business.  What you have to keep in mind is the winnowing rate is going to be much worse on the early rounds.  The VC’s have a much lower sunk cost, it is concentrated with fewer investors, and you have a lot less to show for it.  At the later stages it’ll be a lot easier to argue the company is just fine tuning for some minor challenge or other, but that the market and product fit for that market are well proven.

BTW, whichever path you take, you are signing up for a lifetime of clearing some amazing hurdles.  What’s telling is that when asked about what happens to the companies that are merely “Good” and not “Great”, according to Lacy, Maples response is, “Screw ’em.”  And that’s the problem for the entrepreneur.  Unless you are building a $1 Billion revenue company, and you’ll get the acid test with every round you raise, you’re going to work very hard for low wages and wake up one morning to discover you’re done.  The VC’s won’t put any more in.  The doors are closed.  Note that despite making the Founders millions, and continuing to pay off, with no Board to answer to, 37Signals is merely a “Good” company.  The VC’s would shut the doors on it or sell it off without a second thought.

Welcome to the “Unsustainability of Hyper Growth VC Startups” as I called it in an earlier post.

It’s a crazy world indeed where you can do a fantastic job building a “Good” company and have it be judged inadequate.  If you’re unlucky, you’ll be one of those companies that got to profitability and needs no further investment, but the company just keeps going and going, unable to pay out to the Founders like a true Bootstrap can and unable to achieve a Liquidity Event that satisfies the VC’s appetite.  They’ll be after you to sell the silly company out where their preferences will put most of that return in their hands or to take some extreme risks in order to pivot and have a shot at one of those $1 Billion opportunities.

Here’s a radically different way to think about the capital:

1.  You need to go most of the way through Boostrapping to start.

2.  If you wind up with the kind of wildly successful company that just might qualify to a VC as one of the 10 “Great” companies, you can always raise the money later.

3.  If you are measuring everything the way you should, you will know if you could’ve been “Great” without having to spend the money.  Remember, the VC’s were going to dole it out pretty slowly anyway.  Your biggest obstacle is you won’t have the capital to make it on an advertising model or to give away your product for years while you ponder possible ways to monetize it in your Ivory Tower.  Good luck with that stuff right now anyway.  Andreesen Horowitz VC Chris Dixon says 10 million users is the new 1 million and Fred Wilson says the late stage world is switching to Enterprise which isn’t ad-driven anyway.  Having to actually charge for your product is a small price to pay.

4.  Given all that, you’re not talking about an awful lot of personal investment to just build the company until it pays your bills.  If need be, you can follow the 37Signals plan and invest 10 hours a week.  You’re going to be either spending your savings or your spare time, but let’s face it, are you really an entrepreneur if that bothers you?

5.  Fast forward down the road.  You’ve done extremely well.  You paid your bills by year 2 like many Boostrappers have.  You have a company that has doubled beyond that every year for 5 years.  Maybe you did even better.  You’re sitting on a company with less than 20 employees (probably 10 or 12) that’s doing $6 or $7 million a year.  If you have something that could be “Great” in the VC sense, you’re probably doing $10-12 million or more.  Now if you really want to swing hard for the fence, go raise VC money.  Do it like the Github guys did.  Take down $100 million in capital.  Cash out $10 million for yourself and put that in the bank.  Keep running for that brass ring and be secure knowing whatever happens, you not only have the $10M, but you built the company the way you wanted without a lot of interference and you’ve had to give up far less equity because you waited.  Or, forget the VC’s.  Keep putting several million of the company’s $10-12 million a year in your pocket.  Keep doubling every year.  Don’t wait for them to say, “Screw ’em” because yours is just a “Good” company.  Now you’re the one who can say, “Screw ’em”.  And remember, the more successful you get, the more easily you can raise money or sell the company to a larger player.

It’s not bad work if you can get it.  Come on–you really going to take those Two Aces (a “Good” hand) and turn them in because you hope for a Royal Flush (a “Great” hand)?

4 Responses to “The Series A Crunch: One More Reason to Bootstrap and Skip Venture Capital”

  1. Having gone down both the bootstrap path and (now) the VC path…that sounds like a great plan in theory, but it’s not so easily executed. What percent of bootstrapped companies actually get to $6M in revenue? Certainly not 20%. Maybe 0.002%.
    Take a look at the Inc 5000. Out of 23 million small businesses in America, these are the 5000 that are growing the fastest. How many of them are doubling every year? There are only about 2500 companies in the United States that have doubled revenue over a THREE year period. 2500/23000000. That’s it.

    There is virtually no business model on earth that can support a company with 10 employees doing $6 million a year in revenue. Any business that can scale and maintain $200K revenue per employee is doing amazingly well…$500K revenue per employee at the early stage and doubling every year would be unprecedented.

    This post is based on faulty assumptions.

    • Illya, I have also been there and done a lot more of that. What I’m telling you in this post is based on facts rather than assumptions. To succeed with a bootstrap as I describe, you will need to do something more than affiliate programs for dating sites like you did in your college bootstrap. And, nowhere have I said any of these plans VC or Bootstrap are easily executed.

      CNCCookbook is my 7th startup, 5 reached a conclusion with 2 major acquisitions and 1 IPO while 2 are still in motion, including my CNCCookbook bootstrap. I’ve raised a lot of VC along that way and I have also talked to a lot of successful bootstrappers. Check out the history of companies like Craigslist, SmugMug, or 37Signals at various points in time and revenue. You will see the numbers I have given are achievable and I’m not the only one who says they are higher likelihood than a VC deal–37Signals and many others are on the same boat. Heck, many VC’s I talk to are on the same page. They’re very clear about telling entrepreneurs that not every deal should be a VC deal. Remember too that the Inc 5000 doesn’t even have all the data. Plenty of businesses don’t participate and their records are private.

      If you want to get to exceptional results like $500K per employee, or even $200K, you will have to do exceptional work and you will need a strategy to make winning easier because you don’t have the dollars or manpower to just brute force your way there.

      Here’s some food for thought:

      I see you saying your new company, MixRank, has 3600 trials after raising your $1.5M and you have a page full of smiling faces on your About page–lots of employees already. I’m just now moving beyond the “doing amazingly well” $200K per employee stage, and according to SEMRush my organic search traffic is nearly 10x what MixRank gets. Using content marketing and organic search rather than advertising is just one of things you’ll need to do to make a bootstrap efficient. I see you have published 35 articles to your blog in 2012. I have done 34 so far in 2012 on this Smoothspan blog alone. I do 4-5 a week on the CNCCookbook business site. On top of that I write the software, handle the ops and orders, do customer service, plan the strategy, yada yada. BTW, I had a full time job up until June, I’ve taken 2 vacations so far this year, I have a family, and still got all that done.

      Is it just a matter of cranking out a lot of blog posts? Heck no! I spent a lot of time developing some very analytical digital marketing strategies that facilitate and optimize the content marketing.

      Eventually, I will tell the whole story about everything I did to get the company built, but I want to take it to 7 figures in revenue first. The biggest thing I can tell you is that if 1 person can do everything I have done so far, the model is scalable and they can get to $500K in revenue per employee. Meanwhile, you’ll see dribs and drabs of the story along the way and I’ll keep an eye on MixRank to see what I can learn from you.

  2. Welcome back Bob, loving having you back calling it as it is…

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