Investment increases your risk

http://swombat.com/2013/12/27/investment-increases-risk

by swombat • 13 years ago

194 111 13 years ago

theboywho• 13 years ago

The startup world is so complex and sometimes random that you can't just come up with a general rule, add "almost" and think you nailed it.

There is no general rule when it comes to investing and no "almost" is gonna change that.

Please stop thinking there are general rules to "correctly" doing a startup.

swombat5• 13 years ago

I agree with your specific point but not with the general feeling implied. I'm the first one to agree that all advice is contextual.

However, my observation there is based on the people I speak to. Many first-time founders that I speak to (in London or parts of the world other than Silicon Valley) think that funding will reduce their risk. For most, that is incorrect. Therefore, saying that in the contexts which I've observed, it's almost never good for first-time founders to raise funding seems like a fair statement, and useful to most readers in the category of first-time founders or people thinking of starting a business.

thirdtruck• 13 years ago

I would posit that studies of lottery winners and human psychology could help predict the behaviors and fates of founders that receive VC-funding.

Founders may have much better (self-selected) odds of success, but financial management remains a separate skill-set from product/service development and funding solicitation.

Other studies demonstrate that wealth tends to decrease empathy and influence the mind in other ways. Whatever their past history, you are dealing with a different person after they take VC funding. This goes doubly so for predicting your own behavior, given the intrinsic limits of self-awareness.

This is why I have taken a tiered approach to my own creative projects.

I started with a small Kickstarter, just enough to gauge whether people would pay for a novel. That succeeded. Even though the funding failed to cover all the production costs, the several hundred dollars in expenses after that made for a very cheap education in crowdsourcing.

For my next project, I plan to do an anthology. It requires similar skills to a novel, but involves working with many more people, more coordination, and more money. Even if I lost all of my work and had to start it from scratch, though, it would only put me out a few thousand dollars.

Only after a such few projects, each of increasing complexity, will I take on even a small-scale video game Kickstarter. By that time, though, I will have mastered all of the production skills and will only need to ramp up on each.

And the most important of those skills? I will know what to do with thousands or tens of thousands of backer dollars. That way, even a wildly successful Kickstarter (and video games are the most-funded category) will require managing perhaps only 10x more money than before, rather than 100-1000x. I will already know what I don't require to get a project out the door.

eoghan2• 13 years ago

I agree completely.

ry0ohki2• 13 years ago

It seems to me:

VC funding = 1% chance of being millionaire

Bootstrapping = 15% chance of being hundred-thousandaire

sjtgraham2• 13 years ago

If you want to be a hundred-thousandaire, take the highest paying programming job in SV or on Wall Street. 100% success rate.

Also, 37Signals. They're bootstrapped and definitely outliers but DHH does well enough out of it to race Porsches and commission Pagani to make him a custom Zonda. The sticker price for a production Zonda ran between $1-2MM depending on model.

collyw• 13 years ago

Selling your soul somewhat.

swombat5• 13 years ago

If you want to be a hundred-thousandaire, take the highest paying programming job in SV or on Wall Street. 100% success rate.

Except that doesn't work, because your living costs go up massively, and you also spend a huge chunk of it on taxes... see the beginning of http://swombat.com/2013/7/24/embrace-desire-money for some thoughts on this.

ry0ohki2• 13 years ago

Don't get me wrong, you can still become a millionaire from a Bootstrapped company, the odds just aren't as high.

thejteam• 13 years ago

"...but being first-time founders, they are already carrying enormous amounts of risk, because they don't know how to run any kind of business, let alone a mega-successful high-growth tech startup."

I think the author is right if for no other reason than this statement. Running a business is hard enough, but taking investment increases the complexity of the business side of things. And that alone increases risk.

graycat2• 13 years ago

because they don't know how to run any kind of business, let alone a mega-successful high-growth tech startup.

(1)For "run", this is a common statement, but I believe that it is contradicted by oceans of simple observations: The US, coast to coast, village to the largest cities, is just awash in solo founder, entrepreneur, small and medium family businesses. Examples include auto repair, auto body repair, grass mowing and landscaping, plumbing, residential and small business electrical, roofing, carpentry (e.g., for a deck), swimming pool installation, dentistry, family practice medicine, restaurants of various kinds from franchised fast food to pizza carryout, Italian red sauce, French bistro, and Chinese carryout, a hardware store, a restaurant supply store, a huge range of big truck, little truck businesses where the owner buys in large quantities and sells in small quantities, independent insurance agency, medical testing lab, and many more with variety too large to characterize. E.g., in my neighborhood the shrubbery around a house was too large. So, a team came in with a simple chain saw and a few simple tools, and cut way back all the green, loaded it on a large sheet of plastic, dragged it to some woods, and piled it where it will slowly decompose into 'soil'. Apparently the team was recently from Mexico, but they had a nice, new pickup truck.

There are millions of such businesses in the US where the owner, sole proprietor makes money enough to be a good breadwinner, and the more successful such owners make money enough for a vacation house, a restored muscle car and other toys, and a 50' yacht. In my area it appears that the electricians work four day weeks, i.e., Friday is golf day.

For example, a guy good at managing 10 fast food restaurants can pay himself over $1 million a year.

Flatly, these business people definitely do know how to "run" their businesses. Even a guy recently from Mexico, China, or India can quickly learn how to "run" his business.

(2) For "mega-successful high-growth tech startup", if this is a serious problem, then there is an easy solution: Convert the business to a mega-successful low-growth tech startup. Generally conversion from low-growth to high-growth is challenging but conversion from high-growth to low-growth is easy.

A guy in business who is able to get plenty of paying customers can get a lot of advice on how to run a business from bookkeepers, accountants, lawyers, business insurance agents, bankers, friends, mentors retired from business, etc. It works, everyday, all across the US, in many millions of cases. It's putting kids through Ivy League universities, paying for family winter ski vacations and summer boating/fishing vacations, paying for high end cars from Mercedes, BMW, Cadillac, Lexus, etc., paying for single family homes at $500,000+, etc., and rarely with any formal training in how to run a business.

The general idea that how to run a business is really obscure knowledge is wacko; tell that to a guy doing well mowing grass -- three teams, each with about $100,000 in equipment -- with much less than a high school education, poor knowledge of English, and recently from Mexico without benefit of papers.

If an information technology business can get customers and revenue, then how to "run" the business is something many millions of sole proprietors learn on the job and not some secret, black art.

mcintyre1994• 13 years ago

I agree with your general point, and I'm inexperienced in this stuff - but isn't converting from high growth to low growth going to spook VC investors? I mean, you're probably right that people can figure out how to run their business - but is that conversion reasonable with investment?

soneca4• 13 years ago

"Most first-time founders are broke." (...) "new founders should be looking to decrease their risk, not increase it" (...) "And therefore, first-time founders should almost never take funding."

I am a first-time founder, I am broke and I am taking angel money. Because I am broke! In his line of thought, the OP is not considering "broke" as actually broke. He is imagining some kind of "broke" where you still can pay your bills, your food, your rent.

No, I am broke. I have two options for January/2014: (i) get some angel money, aka, be paid to work on my own company or (ii) get a day job and turn my startup on a side-project, aka, killing its chances to be something profitable.

This is not about risk, i am broke. No bootstrapping options for me anymore, this ship has sailed. So, angel money is a much better option. If I make a success out of this company, even if this does not make me rich, now I am a experienced founder, with a track-record and, some money. I can bootstrap my next company with far less risk and even fundraise on much better terms. But now? I am broke, that's the point.

swombat5• 13 years ago

Option 3: Start a business with a business model that allows you to generate revenue in month 1. It sounds like you're using the funding as a cushion to protect you from having to build a profitable business RIGHT NOW. See this article http://swombat.com/2011/12/8/investment-cushion-springboard

With option 1, you're still going to be broke, but in a year's time, or whenever your money runs out and you realise you still don't have a business that makes money.

Nothing focuses the mind on finding revenues like being broke and needing to make the rent.

(I've been there. I was broke when I started my second business. We raised funding. Three years later when we ran out, I was still broke. I am fairly convinced that if we had raised no money we would have been much more likely to succeed, since it would have forced us into tangible, serious discussions with our potential clients immediately, and forced us to learn to sell right away)

dsirijus2• 13 years ago

  Nothing focuses the mind on finding revenues like being broke and needing to make the rent.

True. That's why I found an angel. It's easier than build a business. One step at a time.

soneca4• 13 years ago

I completely disagree about "Nothing focuses the mind on finding revenues like being broke and needing to make the rent." I know that a lot of people out there believe in this "desperation leads to solution" mantra. But I don't. I work much better and I am much more focused when I don't have to worry about bills.

I started to sell my product from month 1, but wasn't able to generate revenue from month 1. I have a SaaS for restaurants, the sales cycle is longer than a month, no restaurant (around here) close deals at the end of the year - this I learned from experience, but also from successfull and experienced entrepreneurs from the same market; also advised by these successful founders I am offering a 3-month free trial for the first clients. The advice actually was "you will only charge after the 10th client, you need social proof first of all, so give your product for free and then charge after the 10th early-adopter."

So, there is no way I can be profitable before March or April. Ok, maybe I am no sales wizard, maybe I am not good enough on this founder thing. But the point for me is, I am broke, and I already started my company, and I can't make it profitable. As I can't choose option 3 "go back in time and found another business" and I am not ready to quit this business, I will take funding.

delinka• 13 years ago

"Nothing focuses the mind on finding revenues..."

So I spent months attempting to chase revenue (i.e. looking for the next thing that might make money now ...) instead of building the business I wanted.

ChristianMarks2• 13 years ago

"Nothing focuses the mind on finding revenues like being broke and needing to make the rent."

Research shows that the cognitive load associated with being broke amounts to a loss of one standard deviation in IQ. The mind is focused all right: only on making the rent and on nothing else, and under no circumstances on anything like starting a business.

tgflynn• 13 years ago

"Start a business with a business model that allows you to generate revenue in month 1"

It doesn't seem to me this is very realistic.

My impression is that building any kind of serious SaaS is going to be at least a 6-12 month project for a single developer.

Even ideas like blogs with affiliate marketing revenues probably take about a year to generate enough users to make sufficient money to support oneself and simple pure ad supported sites seem to require at least 100K+ users to make money (ie with RPM's around $1).

Is it really possible to start a software/online business that will earn significant revenue in 2-3 months ?

EDIT: Excluding consulting/freelance work of course.

webwright• 13 years ago

"Start a business with a business model that allows you to generate revenue in month 1."

Funding is for companies who want to be big/great. Most big/great opportunities have a cash-intensive front-end that scares away most entrepreneurs. It's not a "cushion" - it's a MOAT. Funding is the boat that gets you across it. There are certainly exceptions, but I don't think it's fair to assume he's "using funding as a cushion".

JamesNelson• 13 years ago

I've noticed a few people say they've just gone out and found an angel instead of working freelancing/etc. during development. Out of curiosity - how do people go about this? Do you meet people through your existing contacts? Do you search on the internet? Do angels generally need to be people in the same country?

troels• 13 years ago

Angels are - almost by definition - very personal relationships. As such, I would think that most angel investments are done through your network.

mhp• 13 years ago

One consideration is how much control you give away when you take funding. If you retain control of your board, and generally take beneficial terms on the funding, it doesn't have to change the way you run a bootstrap business. Case in point: 37signals.

There are money other examples too. I know a very popular business that is successful, VC funded and will likely not have an exit because the founders retain control and they don't want to do that. There are other options (dividends, secondary markets) that can give liquidity.

tcgv3• 13 years ago

The title of the article should be:

- Investment decreases Expected Return [1]

More money won't increase the risk of your business failing, it will simply decrease your share of the profits if your business succeeds.

[1] http://en.wikipedia.org/wiki/Expected_return

tptacek12• 13 years ago

No, because accepting VC forecloses on a class of exits: the single-digit or low-double-digit-millions ones, which are the most common kind of exit, and which would be highly lucrative if you hadn't accepted an investment. You could accept such an exit after taking VCs, but your share of the profits won't be so much "decreased" as "destroyed".

Getting to a mid-double-digits or better exit requires a different kind of execution and a different kind of luck than the lower kind, so, in fact, your risk does go up, because the bar gets set higher.

tcgv3• 13 years ago

I believe we're addressing two different things here. On the one hand I'm talking about the "risk of business failure", on the other hand you're talking about the "risk of making less money".

Hence, I agree it makes sense to say that "investment increases the risk of making less money", which is almost the same thing as saying "investment decreases expected return".

eoghan2• 13 years ago

I don't generally disagree that first-time founders should think carefully before raising venture capital, but the example used to back up this statement is misguided on two counts.

1. It implies that your VC partner(s) can decide to sell your company without your wish. For the size of business mentioned here, this is unlikely. E.g. Even after we raise our next round (Series B), an acquisition can't happen without the founders' concent.

2. 2x liquidation preferences are not standard these days. I don't know anyone who's raised on more than 1x.

I think the author has a relatively refreshingly fair view on raising capital vs. bootstrapping, but the misunderstandings I've highlighted are typical. For any aspiring entrepreneur, I can't more strongly recommend you do your homework before deciding that raising venture capital is not for you.

antr5• 13 years ago

IMHO, even the 1x liquidation preference is a clause that screws up the entrepreneur and the company. If I raise $5m in year 1 and end up creating a company after 6 years worth $5m in equity value, the VC should take the -50% hit, but they should not be allowed to screwup the entire cap table, exit/liquidity options simply because the VC went in at a high price.

This 1x-2x liquidation preference clause is unheard of in any other asset class, be it debt, mezzanine, etc.; and it's not even used by investment funds, private equity, and other professional investors.

tptacek12• 13 years ago

Then don't take money with preferences attached. Good luck, though, because preferences correct an incentive imbalance that is extremely concerning to venture capitalists (that you'll happily accept an outcome that will lose money for the investor).

dennisgorelik• 13 years ago

If you got $5M investment and then sold the whole business for $5M then what exactly did you (as a founder) contribute?

And if you did not contribute anything, then why do you expect to get paid?

arikrak• 13 years ago

It can make sense to take the funding instead of bootstrapping, so you don't risk losing all of your own personal money. The article didn't really address that issue.

viame• 13 years ago

Taking funding is ok as long as you write your own rules and the other party agrees, of course they need to be somewhat reasonable. I also agree that having some revenue prior would be much better, that way you know what you can expect in a month, two months, and so on. Of course, those are just business predictions, but these predictions can be very useful when taking a loan of some sort. Then you can actually do something like "I need 50k for 1 year @ 20% interest, here's my revenue, I will grow this business to x", write a 12 month contact and off you go. Do not give shares right off the start. There are people out there that will want shares, there are people that will give you a private loan, there are no banks that will do that (haha), and of course there is family, friends etc. Just don't f-it up if you're going this route.

I have been working for myself since 17-18, 10 years of self employment. I have been in the food industry (disaster), construction and web. I have had every single position at a company you can image. Just now, I think I can run any business (of course with more failures). I am just not there yet, taking my time, we'll see what 2014 has for me.

pg7• 13 years ago

This is the crux of the argument:

"If you raise funding, however, it cuts out a number of the middle options. VCs will definitely want an exit, and if the exit is too low, this can turn a fairly decent success into a relative failure for the entrepreneur."

However, in my experience (which is now fairly extensive), this scenario is a vanishingly rare one.

Raising a lot of money can certainly be dangerous, but not for the reason Daniel thinks. The big danger in raising lots of money is that you'll spend it-- that you'll let this pseudo-success (with investors rather than customers) go to your head, ramp up your spending before the company is ready, and then put yourself into an impossible position later where you've burned through the money and need to raise more but haven't achieved the results you'd need to do so.

In other words, venture funding is dangerous in the same way any power tool is.

tptacek12• 13 years ago

My (recent) experience with friends at startups suggests that in accepting venture capital and giving investors board seats, you're going to be pulled hard towards ramping spending: your board will want to see things like a formalized marketing team led by an experienced VP/marketing, and you'll quickly find yourself having to argue against spending more money. It's not just that funding goes to your head.

Also, while I defer to your experience, maybe the vanishingly rare "marginal exit" scenario Daniel talks about was once more common; the two companies I was at prior to this one both faced it. Or is it possible that it only appears rare because nobody entertains the idea of a marginal cash exit for a VC-funded startup anymore, knowing what a headache it'll be?

mathattack• 13 years ago

My (limited) experience with funding is the opposite. Rather than request an experienced head of marketing, they wanted an experienced CFO to be the adult in the room.

I think the question of funding comes down to, "Would you put this on a credit card with a 30% interest rate?" If the answer is yes, and you don't have the credit card available, then funding is ok. The reason is that you're expecting a return much better than 30%. If funding can give you a product edge so that you're winning 5 enterprise deals out of 10, rather than 2 out of 10, the numbers will probably make sense. If funding allows you to do a marketing campaign with real analytics and AB testing that will change your growth rate from 10%/month to 20%/month, it will probably be worth it.

pg7• 13 years ago

Yes, it's true a lot of VCs will encourage you to spend faster than you should. I warn about this in essays and in a lot of individual conversations with founders. But fortunately they can never do more than encourage, because founders almost never give up board control in funding rounds nowadays, at least not in the US.

As for marginal exits, I think the biggest reason they're rare is that there is not that much demand on the buyer side. There's lots of demand for HR acquisitions of failed companies, and there's demand for high fliers, but Facebook and Google et al are not looking for small, moneymaking businesses.

solve2• 13 years ago

Instead of financial loss, I'm more afraid of losing the IP, company, everything I've made prior to my investors even joining, because the investors or their successors suddenly feel like kicking me out someday.

tptacek12• 13 years ago

Losing IP used to bother me, but in hindsight turns out not to have mattered.

The fully integrated system you built failed in the market; its value is illusory (if you got to keep it and redeploy it, you'd probably lose in the long run).

The components of that system probably aren't lost to you at all. First, nobody cares about them anyways (VCs aren't going to chase you down for repurposing some scheduling library you built for your restaurant app). Second, while you operate the company you always have the ability to open-source them as you go. Third, once you know how to build a component, it's pretty easy to rebuild it.

thatthatis• 13 years ago

Thanks for sharing the view from where you sit, that's insight that's hard for most of us to pick up on our own. Do you know of or have any shareable data on venture backed founder returns?

What's your take on if funding shuts down a "pivot to a lifestyle business"? I've always looked at the outcome venture most strongly closes down as "$300k a year pseudo annuity." Basically the kind of business returns profiled in the $100 Startup book.

3pt141592• 13 years ago

I think your experience is too biased to be useful for people outside of YC/Palo Alto/California/America. Even besides the caliber of people that get into YC, the immense network and support system as well as caliber of investors probably makes your advice less relevant to most startups.

tptacek12• 13 years ago

YC/Palo Alto/California/America/Continental North America/Western Hemisphere/Terrestrial Earth/&c

davidw• 13 years ago

However, in my experience (which is now fairly extensive), this scenario is a vanishingly rare one.

Your experience mostly corresponds to Boston and Silicon Valley, though, correct? I do not have your experience, but I read a lot and keep my ear to the ground, and, not living in those areas myself, got interested in the "micropreneur" idea - stuff like what patio11, Rob Walling, Peldi (Balsamiq) and company are doing. The numbers - at least those I've seen - don't generally seem like they would be a win for investors looking to put millions into something and get multiples of that back. However, at a personal level they seem to be doing very well for themselves. It strikes me as a model that is perhaps more applicable to "the rest of the world" where the ecosystem is not, nor likely ever going to equal that of Silicon Valley.

Of course, I do not think there are any recipes or hard rules for any of this: some companies need VC and need lots of it to be able to do anything, because they've got grand schemes that change the world. Others don't and would be better off without the distraction.

edanm• 13 years ago

One thing which might skew your statistics, is that taking VC funding or going to YC is itself the result of wanting a large success being your mindset in the first place.

In other words, it's true that investors don't necessarily have leverage over founders, and I'm sure the scenario that Daniel describes is just as rare in YC as you say it is.

But the reason this is true might be that the kind of people who go to YC are also the kind of people who want to take a 1-in-a-million shot at big money, rather than taking more conservative odds for less money. And one of the reasons this is true, is that founders don't understand the statistics and the risk profiles of their options, or in many cases don't recognise that they even have options in the first place when choosing what type of business to build.

Daniel's meta-point about founders being able to choose which kind of business they will build, including choosing it's risk profile, is something I hope more and more founders get exposed to.

pg7• 13 years ago

That could be. At least at YC there are comparatively few misunderstandings about what's expected of companies that take various kinds of investment. But if there are people out there who are unclear about what kind of company they want to create, or take money from investors without understanding what the investors expect in return, I could imagine there would be trouble down the line.

mcguire3• 13 years ago

"However, in my experience (which is now fairly extensive), this scenario is a vanishingly rare one."

Wasn't there just recently a link[1] on HN about a startup that was bailing (and returning the remainder of it's VC) because it was only growing at 20-30% per month?

[1] http://blog.ridejoy.com/from-carpool-to-deadpool-ridejoys-st...

pg7• 13 years ago

If they were truly growing consistently at 20-30%/mo they should never have quit. 20%/mo is almost 9x a year. That's a fabulous growth rate. I'm guessing they meant they grew at 20-30%/mo for a while and then things slowed down.

sridharvembu• 13 years ago

I think of most VCs as "money brokers" or "money salesmen" rather than as capitalists or investors. A company taking in $100 million in venture capital is basically enabling the VC partner(s) to earn $2 million a year annuity until an exit. That 2% annual commission (that's what I call it) on every invested dollar is a substantial incentive on the part of the VC to push more and more money on companies that a) may not need it b) would be unwise to spend it.

I don't see any justification for the 2% on ever-larger rounds of investment. The work VCs do on a $100 million investment is not 100x more than the work they do on a $1 million investment. I hope that model gets disrupted!

pg7• 13 years ago

That's true of mediocre VCs, but it's not true of top firms like Andreessen-Horowitz or Union Square Ventures. Those guys do a lot more than write checks.

grinich• 13 years ago

Do you know of any hacks to minimize spending?

I ask because given the funding climate right now, it seems foolish not to raise more capital on great terms. It's especially true for first-time founders, who don't have an intuitive sense of how much the startup will need. (Or personal assets to float the company, if needed.)

It's also not clear how to maintain a sense of urgency or frugality when other startups are paying crazy salaries and throwing huge parties.

Perhaps this is less about spending money, and more about staying focused.

pg7• 13 years ago

Don't hire people. That is where startups spend all their money.

Hiring too fast is doubly constraining. It increases your costs, and it also makes it harder to change direction.

fblp• 13 years ago

Outsource tasks that cost human resources but are repetitive and easy to systemise. For example, you can outsource market lead generation, social media posting and other data entry for a few dollars an hour. Or get interns (be careful about the management cost of interns that will only stay for a short time).

japhyr• 13 years ago

This is an interesting conversation to read through, so I made a poll asking whether people on HN are looking for an exit or building a lifestyle business. If you'd like to respond to the poll, it's at:

https://news.ycombinator.com/item?id=6970735

jusben1369• 13 years ago

"For example, building a business worth £20m is a pretty amazing achievement, but if you've raised £10m from a VC to get there" Building a business with little or no funding to be worth 20 million is amazing. Taking 10 million to build something worth 20 million is an abject failure and should be treated as such.

tomasien3• 13 years ago

I don't think creating a "startup" style business, with a scalable-repeatable business model, that is only mildly profitable is particularly common. Either you can be pretty darn profitable, acquihired (usually brokered by investors), or fail.

Daniel seems to be talking about lifestyle businesses maybe, and I agree - lifestyle businesses will be ruined by investors and decreases the odds of a big personal win far too much.

michaelochurch• 13 years ago

There is one really strong reason to take VC funding: to eliminate all personal financial risk. See, personal financial difficulty is pure poison and if you can eliminate the risk of it entirely, then go ahead and work with a VC to do so.

If your deal with the VC is going to allow you to move seamlessly from your day job to paying yourself enough to cover your living expenses (say, $10k per month) running a not-yet-profitable business, then take it and feel no shame. Yes, the VC is now your boss, but that's OK because you have the security of a typical job.

Right now, though, the VCs only want to work with people who are already showing traction and don't need them. That's their prerogative, but that means that almost no one they want to work with should be working with them. If you don't need VC, then don't take it. It really is the capital of last resort.

What you should never do is let VCs in to your bootstrapped business where you already took personal financial risk for over a year. You've put a lot on the line, while they're taking no break from their cushy $500k++ jobs. It's only fair, given that comparison of conditions, that they should be in the outer darkness.

morgante3• 13 years ago

Agreed 100% on the value of eliminating personal financial risk.

However, I do think that it's possible to get enough traction for investment without taking on any personal financial risk. You can build an MVP over nights and weekends and start selling it enough to demonstrate market need. For good VCs, that + a compelling story should make them interested.

gpcz• 13 years ago

I think this depends on whether you're looking at funding from a business-centric or founder-centric perspective. The business-centric contention is that you should only seek funding once you have a business idea that all your analyses show would be immensely profitable except for your company's lack of money, since otherwise you're adding unnecessary risk.

Founder-centric organizations like Y Combinator (I've never been funded by Y Combinator so please correct me if I'm wrong with this assessment) seem to have different dynamics and motivations. Instead of investing in the business, they invest in the people much like a college -- realize they are going to screw up from their inexperience, but give them angel-level amounts of money, latitude to pivot, and world-class networking opportunities and help.

morgante3• 13 years ago

This is an article about return, not risk. Taking VC money in no way increases your risk—you're not personally liable for that money and a failure still ends with $0.

I'm not sure whether the change in return value matters enough to avoid VC money, but I do know that taking VC money absolutely 100% decreases personal risk.

If you bootstrap, you're investing both your own time and your own money. If the company fails, you've just lost a lot of time AND wiped yourself out financially. That's a huge risk.

If you take VC money, you're only investing your time. Yes, you might make less money off middle outcomes, but you've also eliminated all financial risk to yourself. There's no way that you walk away from a venture-backed startup with less money than you had going in.

I don't think anyone should consciously be advising the first option (bootstrapping) to anyone who is risk-averse.

bushido• 13 years ago

The story focuses primarily on external factors that could remove choices and control from the founders, but it feels a bit one sided, in that Daniel is externalizing the factors concerning funding.

Hence, I'd like to digress a pit from the story and draw attention to some internal (mostly psychological) reasons to take funding ... or not.

Drawing from experiences and observations from investment management and investors behavior (mostly) outside the sphere of start-ups, I can confidently say, there are polar opposite behavior that results from taking/using/managing someone else's money.

a) For a fairly large number of people; accepting someone's money brings about accountability and reduces personal recklessness. These individuals usually thrive under situations where they are held accountable and appreciate the benefits of experience, mentoring and someone believing enough to hand them their money. Sure it may reduce some choices, but the perceived value is easily offset by the growth and change is life perspectives.

Most people don't quite think this far, but they should. If first-time founders have seen themselves be more accountability when the burden of risk lay upon someone else, then by all means they should find investors who would help them down this path.

To reiterate, the key for this group of first-timers is to find the right investors/angels for their start-up, Daniel's situation would likely only play out if they were to hasty to take any money rather than the right money.

b) Then there are the inbetweeners, these are the individuals that do not find the value in giving up their choices (however limited the scope) in exchange for the perceived benefits, or lack thereof. Accepting someone else's money may also be viewed as a burden or source of stress and things not working out as intended may be viewed as failure or reason to give up.

If they recognize these traits they should be extremely careful when accepting any funding, and this is the group that would most benefit from Daniel's observations.

c) On the flip side of the first group are the individuals that are extremely callous when taking additional risks, over spending, living beyond the constraints of their current situation when someone else's takes on the burden of the risk.

I don't want to judge, but I would find it rare for these individuals to not take funding. They would mostly be the personalities that seasoned angels and investors recognize or watch out for. Perhaps VCs of the yester-years may have liked them. I personally see them as more dangerous to investors that the removal of choices are to their success.

I am sure the psychological profiles are also a good thing to know and understand when choosing co-founders, and that would be a greater concern than taking funding, but I'll leave that for another day or another topic.

JoseVigil• 13 years ago

I agree with the authors perspective. You want to give your dream up start pitching, if you want to make it real start working.

cpks• 13 years ago

Investment decreases your risk. Before investment, you have a 50% shot at zero or negative ROI. You have a 35% chance at salary-level return. You have 14% chance of a low multimillion dollar return. You have maybe 1% odds at a very high return -- if you've got a business model this good, you'll be fighting funded businesses too.

After investment, you have 95% odds of salary-level returns. Investment lets you pay yourself a salary. Your odds of low multimillion dollar return go to vanishingly small -- maybe 1% -- unless you're really at the edge, it is either eaten by liquidity preferences, or bigger. Your odds of very high return jump up to 4%.

notastartup• 13 years ago

This is strictly my opinion.

I keep hearing from people "oh you need funding", "you need to give a way 25~50% for X amount of money", "you need to capture the market".

I just find this extremely annoying. I want to build a business, a profitable one, by not owing anyone anything. I want to be in control because I am passionate about the technology and the problem it solves.

What I can see from a macroeconomic point of view, is the previous generations grasp at innovative output by the younger generation. They are essentially declaring a "piece of the action" for something they see only as a money bet. For someone with a billion dollars, spraying six digits to several companies is not a big risk. Consider how much work that now needs to go in to satisfy their expectation-go big or go home. This is ultimately bad for the consumer choice and the economy. Much human capital and time is wasted when good services and useful product needs to get shelved because they didn't struck a homerun with the investor etc within the time frame allocated.

I don't want to be part of this mickey mouse game. I want to know what it takes to build a profitable business from nothing, because ultimately I'm not in it soley for the money, I want to actually solve problems that I think is worthy of solving, and I need to be able to do this at my pace.

Leverage from outside money is a double edge sword as all day traders know. It magnifies profit but it also magnifies loss. I see companies that just keep on getting money without ever thinking about positive net profit growth, and instead what the next idiot will think the company will make in the "near future", however long that is. I simply do not see this working and neither did Warren Buffet during the dotcom bubble, the idea that share price today is reflected on by not cash earned today but what it could make tomorrow is insanity (la nouvelle économie ooh la la)

I too support bootstrapping vs. funding, I mainly feel that the intellectual value is being exploited by profit at all cost kamikaze capitalism, and I just wonder how the attitude will change when we see the likes of Facebook and Twitter collapse in the oncoming market correction, when the next investor comes along and starts to worry that they won't be making net profit this year or the next or the next, and that it's a giant pump and dump scheme, where the victims will once again be duped investors.

Investment increases your risk

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