Who Needs VCs? Seattle Entrepreneurs Say Bootstrapping Is the Way To Go (Part 1)

12/1/08Follow @gthuang

Should young tech companies seek venture capital, or try to bootstrap their way to profitability? It’s a hot topic these days, especially with the economy and funding climate the way they are. I’ve been asking experienced entrepreneurs around town for their opinions on bootstrapping versus venture capital and angel investment, after I read a recent blog post by Hillel Cooperman of Jackson Fish Market, a bootstrapped Web startup in Seattle.

One caveat: these entrepreneurs were self-selected for not taking VC money in the early stages of their companies. So what they say is not necessarily representative of the innovation community. I’d also like to follow up with thoughts from venture capitalists and VC-backed startups, so please comment below or contact me directly. That being said, here are a few highlights from what I’ve heard back, before diving into the details in a separate post.

— “One of the biggest pitfalls [for] an entrepreneur…is to seek validation from the venture community,” says Christian Chabot of Tableau Software, who bootstrapped his startup for a year and a half before raising venture capital in 2004 and again in August 2008. He adds, “If you’re going the venture route too early, you can count on selling 1/3 to 2/3 of your company.”

— “It hasn’t made sense to us to date to take VC money,” says Steve McCracken of CultureMob, who has gone the bootstrapping and angel routes. “The best return for us on investment is probably a smaller investment. Every buck you take, the exit has to go up that much higher for everyone to get a high return.” He adds, “If you look at the successful businesses, I don’t think there’s a clear correlation with amount of early capital investment.”

— “We typically operate with six employees, yet we have traffic that compares with local VC funded sites that have more than 10 times that number of employees,” says Josh Petersen of the Robot Co-op, which was originally funded by Amazon. “And I’m pretty sure we are more profitable than any local Web startup because of our approach.”

Cooperman helped start the whole discussion on his blog a couple weeks ago. “In our observation, a significant percentage (I think the majority) of companies that are funded by VCs today would be better off as bootstraps,” he wrote. “I believe when a company that can bootstrap takes VC, it can warp their values, and ultimately may lower their chances at success…We’re in a world right now where bootstrapping is the exception (in our industry), and VC is the norm. I think that should be inverted.”

Tony Wright, co-founder of Seattle-based RescueTime, responded to the post with a different view. “Taking outside funding is just trading equity (usually 15-30 percent) for the ability to focus, getting a reliable paycheck, and be able to move at the velocity you want to move,” he wrote in a comment. “Of course, I totally agree with you if taking funding results in the founders giving up control of the board. But for a company that gets funding when they have a bit of traction (increasingly the norm), they generally don’t have to settle for giving up control of their company.”

Cooperman replied, “I think venture capital is a great tool for business where it makes sense. My main issue is that I believe, for the bulk of tech startups today that take it, it’s inappropriate. It’s less about the control issues, and more about the expectations…You may agree that anything less than a 10x return (the typical VC goal) is a failure. And that’s great. But what happens if you take VC, you shoot for that 10x return, and then find out there’s only a 3x return. Now you’re at the crossroads. The VC will push you to do all sorts of things to try and get to 10x. (As they should given their business model.) You may have concluded that not only will the business never produce 10x returns, but trying to morph it into a 10x business will kill your 3x creation. To the VC, 3x and a dead startup are essentially the same given the way they calculate their batting averages. At this point you have a problem.”

I contacted Cooperman, and he declined to name any companies he thinks have taken too much cash. But he told me, “In general, I think most consumer Web startups, unless they have to produce something physical, or buy some type of machinery, or have some unusual technological infrastructure need (indexing the Web for example), or have to upend some huge player in an established market, should always operate at the barest minimum they can.”

[For more comments from the Seattle entrepreneurs, stay tuned for Part 2---Eds.]

Gregory T. Huang is Xconomy's Deputy Editor, National IT Editor, and the Editor of Xconomy Boston. You can e-mail him at gthuang@xconomy.com or call him at 617-252-7323. Follow @gthuang

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  • Hmmm

    So…..what isn’t talked about is that VCs won’t fund any of these anyway!

  • http://www.newscred.com Shafqat

    I completely agree that bootstrapped is the way to go. Starting and running a web-based business has never been cheaper, and the economics of VC funding just don’t make sense in most cases (I say ‘most’ because there are certainly exceptions).

    At NewsCred, we passed on VC funding and are about to close our angel round. We’ve raised as little as possible so that we keep control of the company, ensure we remain agile and creative, and also guarantee that most of the pie is split amongst founders and employees. I wouldn’t want it any other way.

    I also think this trend of moving away from VC funding will continue and will eventually force VCs to rethink their models and innovate their funding strategies.

    Shafqat
    CEO NewsCred

  • http://www.rescuetime.com Tony Wright

    Great post!

    I’m not sure if we should keep calling it VC… I know at least one company in this post that’s taken more in an angel round than we did in our tiny Series A.

    Between Hillel and Robot Co-Op, it seems to be that the biggest danger of VC funding is expectations (both yours and those of your investors) and the lack of discipline that a pile of money can engender (i.e. hiring a new person for every new bit of work that pops up rather than keeping lean).

    VC is great if you think there is a BIG opportunity. But the management team decides how fast to move towards that opportunity. The simple solution is to:

    1) Get a VC that is on board with a growth philosophy that isn’t insane (this isn’t hard– I don’t know why people think VCs are constantly screaming, “INCREASE MARKETING SPEND! INCREASE HEADCOUNT!”.

    2) Have the discipline to treat your bank account like it’s smaller than it is. Keep your team small.

    3) Focus on your product until it’s close to as good as you can make it. Then focus on marketing/sales efforts that are measurable and sustainable.

  • Krassen Dimitrov

    4) If your VCs are hurting the business, expose them to their Limited Partners.

  • Visitor

    It’s too bad some people can’t see beyond their own insecurities and deficiencies to actually hear the message objectively. Maybe thats why *some* people will always be working for one of us, instead of the other way around.
    marire penis

  • http://www.smithenergyco.com Ken Smith

    The only two stable sources of innovation capital in the next 5-10 years will be strategic / corp. R&D, and the federal government.

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