VC Money, Yes or No?
Greg Gianforte, CEO of RightNow Technologies, wrote a piece for Tom Foremski’s Silicon Valley Watcher called “Most startups should avoid venture funding, not pursue it.” At Tom’s request, here is my rebuttal, heavily influenced, to be sure, by my ongoing experience as a venture partner at Mohr Davidow Ventures.
GG: If you start by selling your concept to potential prospects (rather than stock to VCs), you will either end up with initial customers or a conviction that your idea won't work. Why raise money and then find out which one it will be?
GM: If the offer lends itself to being delivered as a project, this approach is fine, assuming you can assemble the necessary back-up band for a pick-up gig. But if you need infrastructure, inventory, or employees, this is not an option.
GG: Raising money takes time away from understanding your market and potential customers. Often more time than it would take to just go sell something to a customer. Let your customers fund your business through product orders.
GM: My experience is that raising money actually forces you to think more deeply about your market and potential customers than you otherwise would because investors won’t fund you unless you come up with genuinely new insights. And since investors are selected by Darwin to be effective crap detectors, you can actually learn a lot from the fund-raising process.
GG: Adding VCs to the mix early gives you an additional set of masters you must serve in addition to your customers. It is always hard to serve two masters, especially in a startup.
GM: Yes, investors represent a constituency that is different from customers, but each has a key role in a start-up. The customer helps you build a better offer, the investor, a better company. If that has not been your experience of VCs—and I know for many it has not—it just means you’re working with the wrong ones.
GG: With no money you can't make a fatal mistake. This is a blessing. Without VC money, you are forced to figure out how to extract funds from your customers for value you deliver. Ultimately that is the only thing that really matters.
GM: Oh, please. Without the risk of making a fatal mistake, what makes you think you are going to generate a venture-like return? If that is not your intention, why would you talk to a VC under a false pretense? Let’s be clear here: Extracting funds from customers may be deferred by funding, but only in the interests of creating a greater extraction down the road. Never mistake capital for income.
GG: Money removes spending discipline. If you have the money you will spend it - whether you have figured out your business model and market or not.
GM: This is what I mean about mistaking capital for income. If you think that by accepting capital from an investor, you can reduce your life risk by transferring some portion of it to them, you sadly misunderstand the nature and obligations of business management. This is how “family and friends” funding can turn sour, not only for the life of a company but for the company of a life.
GG: Raising VC money determines your exit strategy. You will either sell the business or take it public. What if you end up with a very profitable, modest sized business that you want to just run? That is no longer an option once you raise VC money.
GM: True. If your intent is not to create venture returns, you should not talk to a venture capitalist. Not all start-ups have to be venture-backed, as, for example, The Chasm Group, The Chasm Institute, and TCG Advisors can bear witness. Understand, though, we chose our path to produce income with life-style freedom, not to create equity.
GG: You sell your precious equity very dearly before you have a proven business model. This is the worst time to raise money from a valuation perspective.
GM: Precious indeed, but to whom? How valuable can equity be in a firm that has no proven business model? How could you tell? It is indeed the worst time to raise money from a valuation perspective, but that’s true for investors even more than it is for you—as hence the so-called “low valuations.” Don’t kid yourself: market effects rule pricing in all financial transactions including this one.