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Funding

October 25, 2005

When they first learn that I am starting a technology company, most people ask one of the following questions; "what are you doing?" or "do you have (VC) funding?" I think it's the latter question that's interesting. How is it that the image of a technology startup is so inextricably linked to the idea of big funding? With little understanding of what venture capital is, or even what my company is all about, most people are quick to tell me "oh you'll need VC money for a tech startup". This could be a side effect of the massive media coverage of the dot-com craze, but I think it points to a more fundamental problem in the whole system.

I was going to write about the problems of VC money but individuals who are more experienced and much smarter than I have written many good pieces on the topic.

The Unified Theory of VC Suckage - Paul Graham
What Carly Will Be Missing - Robert X. Cringely
Fixing Venture Capital - Joel Spolsky
An Engineer's View of Venture Capitalists - Nick Tredennick

If you do a search you can find many other such articles and I'll try not to reiterate most of these points. I would, however, like to expand a little on the topic with some of my own thoughts and observations.

I've noticed that it's frequently with confusion, fear, or outright hatred that most startup founders seem to talk about venture capitalists. This leads me to believe that something is wrong with the overall system that can't simply be pinned on the venture capitalist, we (as tech entrepreneurs) don't understand the nature of VC.

At "startup school" Olin Shivers, who is a GA tech professor and one of the founders of Smartleaf, gave a very inspirational presentation but I felt one part of it was lacking. One of his slides had the title, "VC's - soulless agents of Satan, or just clumsy rapists?" I laughed. It seemed as though everyone else in attendance laughed. I thought this slide was going to be a preamble to a thoughtful discussion on the nature of VC's. I initially assumed the slide was highlighting simple preconceived notions of venture capitalists that are easy to repeat but too simplistic and generally wrong. Instead what followed was more of these simplistic characterizations, "VC's are lemmings/sheep" and that their interests are not aligned with founders of companies. His presentation also highlighted lots of other easy to repeat negative clichés regarding venture capitalists: the notion that VC's are not technically savvy, are cowards, and generally are managerial bumblers.

A counter point was the presentation given by Stan Reiss, a VC from Matrix Partners, who also spoke at startup school. He clearly started out on the defensive and who can blame him? His message was threefold "everyone doesn't need VC money", "think long and hard before deciding to go the VC route", and lastly "when you need VC money use 'quality' VC firms".

Although Stan was quite forthcoming in his presentation, he still held back on several key things that would have helped the would-be entrepreneurs in the room. What seems clear to me is that venture capitalists are, to a large extent, salesmen. Not only are they salesmen, but salesmen who work off commission. I think this isn't an obvious characterization because what they're peddling is money (capital) and the general populace doesn't generally think of that sort of transaction as sales. This isn't by its nature a bad thing as long as you understand what their role really is. As entrepreneurs, we are using the future value of our company and control as our currency in this transaction.

Why is it important to characterize venture capitalists as salesmen? Salesmanship is mostly about controlling information flow. When interacting with any salesman, the sage advice still holds true, do as much research as you possibly can. Stan left out aspects of what venture capitalists do because it is his job to control information flow. His advice to "think long and hard before going the venture capital route" is sound, but he left out what you should be thinking about and what your decision factors should be. I think it's also useful to point out that there are good and bad venture capitalists, just like there are good and bad salesmen. Stan seemed like a good VC but even good VC's want to control the information flow.

I've been reading some venture capitalist's blogs, and have found many of their authors to embody some of the positive aspects of what we generally imagine VC's to be like. Many of these venture capitalists are former company founders. I've found some VC's who back technology companies seem to be genuinely interested in the technology and are quite tech savvy. Even more interestingly, some of these same venture capitalists are beginning to lift the veil of obscurity regarding venture capital in general allowing more information flow. Venture Blog by David Hornick, Brad Feld and Fred Wilson's blogs are great examples of these. If you read these I recommend the series on term sheets, and the VC cliché of the week. So again, there is a wide spectrum of venture capitalists.

I don't claim to be an expert, but in my view, most VC's are like sledgehammer salesmen who work off commission. The only additional tweak is that they only get a certain number of sledgehammers to sell and the manufacturer bases that number on having a few huge successful projects they can point to, "Yessir that taj mahal over there was built with VC brand sledgehammers". Just like any salesmen, their job is to make you feel like you absolutely need what they're peddling and want you to get the biggest and baddest model they have. The irony is, although much maligned, the product is actually useful in the right context.

I believe because of the hard sell, many of us end up using this tool improperly. It's like using a sledgehammer to build a birdhouse. You may be able to do it but the job at hand would have been much easier with the proper tool. This tool/usage mismatch seems to lead to the frustration and animosity rampant in the startup community, anger at the one who sold you the sledgehammer when you're looking at the splintered remnants of your project.

So when is this "sledgehammer" tool appropriate? First of all I think we must understand what the tool is for, and whether it fits our need. The capital, contacts, business services, and advice given by a VC are all to generate growth. All companies seek growth, but early stage venture capital is for large and explosive growth in a relatively short period of time. Knowing this, I think it becomes possible to effectively use VC money, if it's needed.

Early in the life of most startups, the tools needed are small, precise and can direct very small amounts of energy analogous to a small ball-peen hammer or claw-hammer. This isn't to say it's always true, some startups actually do need the big tools and these are the success stories trumpeted by the venture capital firms, google et al.

It's far too easy when seeking funding to put a "hockey stick" graph in your presentation/business plan. "Of course my company will grow explosively!", but how do you know? Taking into account my "business scientific method" that I mentioned in my previous post, it's hard to know if you absolutely need the tools for explosive growth until you're actually doing it. I think the key is to always start small, and once you have some experimental results and data regarding your approach you can better understand the tools you'll need.

Another thing to keep in mind is that you are trading some control of your company to buy this tool. Why would these salesmen need or want control of your company? Because you must use the tool they've sold you or else they won't get any more to sell to others. You might think it'd be nice to have that sledgehammer in a shed, ready for when you need it, but that's not how it works. These salesmen will force you to swing that sledgehammer as hard as possible. "Think BIG", "grow! grow! grow!" whether it makes sense from your company's standpoint or not. This is where you need to think long and hard as to whether you want to pursue venture capital money or not. You need to be ready for the tool, because not everyone needs it and not everyone needs it at the same point in their company's life.