Building a product people love is a challenge in itself. Now add the need to earn enough money from Day 1 to cover all the development costs, all the experiments, and have a reliable income that will allow you to convince engineers and designers who will be building it to join you. Capable people always have better offers at hand and need to know you will be able to pay them.
Venture capital removes a lot of these hard questions or at least moves them a few years into the future period. You can use investors’ capital to actually build something and test if it’s appealing and can make money. But in the tech ecosystem, people rarely end with just one investment. Most startups instead fall into a running wheel where they raise new rounds every 12-18 months and focus on growth, not pure revenue and certainly not profit. And I see very specific problems with that approach and I believe a significant share of founders would be better off on a different path, a path that we don’t really have a good name for, but a lot of companies have chosen it.
First, raising venture capital takes a lot of time and effort. Spending precious resources in order to be suitable for the parameters of investors does not always contribute to the growth and development of the company. The founders at the early stages are the people who do everything that’s needed. And then they have to stand up and go away for months as they’re trying to raise a new life-saving round. As they’re getting replies from investors, with each day their company’s runway is falling down a bit, making the fundraising process even more urgent and chaotic. Some super-hot companies are able to close their fundraising in a week, but that’s just a few percent of companies. And then, in just 12 or maybe 18 months you have to do it all over again until you sell your company or make it public. When everyone is focused on growth, nobody is trying to build a sustainable business.
There’s a term that investors tend to massively despite – a lifestyle business. It’s a type of business that you can work on for decades, which brings you reasonable profits but is unlikely to grow 10x or more. Venture capitalists need a few startups in their portfolio to grow beyond that to make the ends meet. They’d much rather have you die trying but not stop.
But there’s clearly a whole category between lifestyle businesses and venture-backed companies that use external capital as their life support. The category of companies that use venture capital when they need it but focus on building cash flow-positive businesses. That freedom allows them to survive hard times and wait for the best moment to sign a strategic investor they truly want. Webflow wasn’t raising anything between 2014 and 2019, when they landed a $72M Series A. 1password was a bootstrapped company right until 2019 and then they raised almost a billion dollars – because they found a purpose for all that money and started their expansion into enterprise. All such companies found the time that works for them and raised on the best possible terms.
When you only have a few months of runway, your options are limited. Whether you like it or not, at some point you will have to take the best term sheet you have on the table, and it might not be a good one. Now do it five times. The National Venture Capital Association estimates that 25% to 30% of venture-backed businesses fail, but if by failure we mean stopping at a particular level without growing further, I’m sure the actual figure is much higher.
Our company would never have been created without venture capital. We needed it to jumpstart our operations and build the first product. But since that Seed round in 2015, we haven’t raised any capital. Instead, we built a profitable business that is still growing and even accelerating that growth. We understood that we could clearly continue building that company with the subscription revenue we had and would have in the near future. And that approach suited us, specifically because we’re creating a new market out of thin air and have to educate our users. If you’re building the next Uber or just a 15-minutes grocery delivery you need all that capital to grow as fast as you can and try solving the unit economy and other challenges later. Many companies have tried that. WeWork is now trading at a $5Bn market cap. It’s a solid business, a ton of great companies prefer it for their offices and I have high hopes for them. But the situation they put themselves in several years ago wasn’t sustainable at all at a $47 billion valuation pumped up by Softbank. Brandless was a direct-to-consumer ‘brand’ selling all kinds of goods for your home. They also raised from Softbank, burned all that capital, and lost, while some of their competitors who raised reasonable rounds have figured out the model and endured – and even analyzed the mistakes made by Brandless.
If you raised funding earlier but are thinking about switching to a self-funded growth you have a difficult discussion you need to have. Your early investors might be disappointed if they don’t understand what you’re trying to do. They want to track their gains, at least on paper, and they can only do that reliably if you raise a new round. Explain your vision, show your current growth projections and ensure they understand how they will be able to get out of your business in that model. Buffer actually had to buy out their early investors when they switched to bootstrapping. That might be a way forward. Thankfully, we realized that we’re still aligned with our investors and they continue this journey with us.
This article was submitted by an external contributor and may not represent the views and opinions of Benzinga.