Who Needs VCs? Seattle Entrepreneurs Say Bootstrapping Is the Way To Go (Part 2)

12/2/08Follow @gthuang

What are the arguments for and against bootstrapping a tech startup? When should a company raise venture funding? And what have Seattle entrepreneurs experienced in taking various different paths? I interviewed three prominent local entrepreneurs in the past week to get their thoughts. Yesterday, in Part 1 of this story, I gave some context and a quick preview. Today, I’ll give some more background on each entrepreneur, and let them tell their remarkable (and sometimes surprising) stories in their own words.

—Steve McCracken of CultureMob has experience with venture and angel funding, as well as bootstrapping. In 2000, McCracken co-founded Seattle-based Serials Solutions and bootstrapped the library-software company to an $18 million acquisition in 2004. “We started the whole thing with $8,000,” he says. “Unlike Web publishing stuff, you’re selling and getting money from Day 1. The hurdle to clear to get to profitability was lower.”

“I’d been at a VC-backed startup, and I’d seen the time that went into fundraising,” McCracken says. “When I looked at the time and effort required, basically I thought, I need to develop domain expertise in fundraising. Or with that same time, I can develop expertise in developing and selling my product…That was the basic math. Also, secondarily, in an unsexy thing like library [software], I didn’t think I’d get the money.”

“As a result of that, we were obsessed with revenue, just obsessed with it,” he continues. “The next thing you’re obsessed with is A, making clients happy, and B, selling. When you get to business fundamentals, that was really powerful. The whole organization could say, ‘Listen people, your paycheck is coming from selling the product. We are earning our paychecks.’ There was absolute clarity of objective to the team. It highly encourages focus and discipline on the key metrics.”

On the flip side, McCracken says, “Good investors bring more than just money. They bring connections, and an outside perspective, sometimes a challenging perspective—is this the right course, and why? By reporting to an outside set of investors, it sets higher bar on reporting. It prepares you for presenting your business. More money gives you runway and resources, if time to market is key. Maybe the product can’t be built without outside cash.”

In early 2007, McCracken co-founded CultureMob and has been in the process of raising angel funding. “The difference is that Serials Solutions had revenue from Day 1. CultureMob is primarily ad-driven—it’s got to get to a lot of traffic to make a lot of money. [Angel] capital is allowing us to grow rapidly,” he says. “It’s about being super-efficient, and getting us across the chasm and over to profitability.”

McCracken sums it all up: “We try to do with the least amount of angel funding possible. What are the considerations? If nobody is investing, bootstrapped is the way to go. Or if you’ve got early revenue…My goal is not to walk around town saying, ‘I got X million from the coolest investor.’ I care about building a great business…I’m not knocking VCs, I think there’s absolutely a great role for VCs in the economy…Massive capital isn’t, in this industry, the defining factor. It may be in pharmaceuticals—I’m not going to launch a new drug with bootstrapping.”

—Josh Petersen is the co-founder of Seattle-based Robot Co-op, the developers of popular social websites like 43 Things (which was funded by Amazon). A veteran of Microsoft and Amazon himself, Petersen has a unique perspective on fundraising. “We decided not to pursue the VC route mostly out of disinterest in convincing anyone about our idea or our team,” he says via e-mail. “In our minds, the Robot Co-op is more like a band than a company and going to work each day is more like band practice than working in an office. We sit at one common table, riffing off ideas and trying to put something together that we can be proud of. There really is no room in this approach for a VC/record exec. And what is the point of trying to prove yourself to a bunch of record execs until you’ve had a chance to play some shows and write some good songs? Pitching the band before it is actually playing live is how boy bands (think N Sync) get assembled, really the creation of producers and record execs rather than talent that fronts the band. Funny, a lot of funded companies (not all, by any means) remind me of boy bands, where it is not too hard to see who really pulls the strings.”

“But we also chose not to bootstrap the company,” Petersen says. “We found we didn’t need to bootstrap the company in order to reach our objective…We partnered with a company (Amazon) that had the resources to fund our first 2 years before we arrived at meaningful profitability. We were too small and too cheap to really merit Amazon’s attention and they trusted us to do something worthwhile based on past results. Thanks to that start, now we can use the profits of 43Things to fund other projects. In a way, we took on investment to fund a product, and now we are bootstrapping other products with the profits of the first.”

“What we do have in common with bootstrapped companies is a mad focus on frugal operations,” says Petersen. “We don’t have phones, fax machines, cubicles, business cards, a corporate logo, a PR firm, a marketing department, program managers, advertising, a sales force, corporate retreats, or even a conference room. The Robots use their personal computers for work, that way we skip the whole hassle of having company assets to track or any sort of proper use policies for company computers, likewise we use our own personal cell phones rather than have company phone bills or phones to keep track of. This probably sounds really insignificant (or even foolish) to funded companies. I think that is why so many of them crash on the rocks of a high burn rate. Give yourself the gift of a long runway by focusing on spending from the start. You can buy the swag and aeron chairs when you are profitable.”

“There is one other thought I have on this whole topic,” Petersen says. “VCs love to call companies like the Robot Co-op or 37Signals ‘lifestyle companies’. First of all, I want to assure all entrepreneurs that there is nothing wrong with having a lifestyle or creating a company to ‘bootstrap’ the way you want to live. Isn’t that the whole idea really? If the company you create isn’t going to give you the lifestyle you want, what are you in it for? Life is too short, and the chance of failure too high to put off having a lifestyle you enjoy. But second, I think VCs really use the term ‘lifestyle companies’ to describe companies they would like to invest in, but just can’t. Often this is because the company is already profitable and doesn’t need VC investment. Often too, the company is approaching a market that can deliver rewarding profits to a small team, but which can’t help a VC firm reach the incredible returns they require to make their investment model work. Most entrepreneurs would be overjoyed to have a company that delivers a sustainable profit of $3-5 million dollars. Most VCs would never look at such a deal.”

—Christian Chabot was the co-founder of BeeLine Systems and, more recently, Seattle-based Tableau Software, a data visualization firm that closed a $10 million venture financing round from New Enterprise Associates in August. (Tableau also raised $5 million from NEA in 2004.) In between startups, Chabot was an associate partner at Mobius Venture Capital for three years. “I think the vast majority of venture-backed companies should have been bootstrapped,” he says. “We bootstrapped Tableau for 20 months, with no paycheck. We worked in a warehouse in Mountain View [CA]. The front of the warehouse was occupied by a VC-backed company. We had rat traps. The other company was struggling but spending much more. Too many entrepreneurs do things backwards…The entrepreneur should be undyingly convinced this thing is going to work. You’re there all day. The VC takes four 4-hour meetings, so why is that considered validation? People try to raise money too early, they think they’re getting something more valuable than it really is at that early stage.”

“Why would you raise VC early?” Chabot continues. “You would raise it very early if you absolutely had to. TiVo is a classic example—you need to build hardware or commission a fab [to make chips]. There’s simply no way to get capital…But for online guys, get it up and try to get traffic with a small number of developers working very hard. You want your validation from customers, not financiers. There’s only one source of validation for business, and that is your customers. Every waking moment should be spent seeking reference customers…Always raise money when you don’t need it.” (Chabot points out that Tableau has been profitable both times it raised venture capital.)

Chabot’s time as a venture capitalist from 2000-2002 left a marked impression on him. “Companies with no revenue were out spending VC money,” he says. “Venture capital doesn’t just come from rich guys anymore. Their investors are large financial institutions, banks, pension funds, workman’s comp funds, universities. I left with such a bad taste from all these companies…spending money way ahead of revenue. I thought that model would die after those years. But once the market came back, it was still predominant. VC is a cost of capital. Why is this a milestone? Would you celebrate your bank loan? Is selling half your company worth that?”

But Chabot draws a distinction between venture and angel funding. “Raising venture capital is still communicated as a great victory and used as a point of comfort for employees to an extent it doesn’t deserve. Angel funding, because of the scale—and there’s usually a personal connection—it’s different. I don’t think angel financing is associated as much with internal cultural problems as is venture financing, but it will only take you so far.”

“In bad times like now, you can pretty much count on extremely low valuation for your company,” Chabot says. “Maybe if you do enough meetings and do a great job, you’ll find a financial partner who’ll take 20, 25 percent of the company…But if you have a new venture, should you spend the next 6 months full-time raising money, as opposed to getting some reference customers? One silver lining of an environment with low valuations is that it does bring some clarity to these choices.”

Chabot sums it up this way: “Way more people could bootstrap than do. The two biggest reasons are, one, fear—they’re simply afraid, it’s too risky—and two, a desire for validation. They’re hoping the act of raising venture capital is going to give them what they desperately want. A real entrepreneur [has] neither of those. You think Steve Jobs needed that?…Those are people of action. They don’t care what the world thinks.”

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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  • http://www.buzzfund.com lthompson

    Grfeat approach, permits sharing more equity amongst employees, teamwork, sense of we are all in it together, and ultimately, it slike going a shore and burning the boats, you have to stay and fight! Amazes me how fully funded and complacency are directly correlated.