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Over the weekend Heidi Roizen wrote a post that was extensively shared across the tech industry: “How to Build a Unicorn From Scratch — and Walk Away with Nothing.” Go read it right now if you haven’t already, it’s well worth your time; I can wait for a moment… will make an espresso in the meantime.
Done? Good. Now: I have three issues I’m juggling with these days. One: even if things go well — say, an IPO — once you dig into the numbers, they’re exciting for the investors, not that exciting for the entrepreneurs. Sure, the entrepreneur made a company public, and that’s a huge life achievement that deserves major props. Hurrah.
But. Aaron Levie had 3.4 percent of Box by that time after 8.5 years of hard work (you can see a nice infographic on that here from my friends at EquityZen). Renaud Laplanche had 4.7 percent of LendersClub at that time after around 7 years of hard work (another nice EquityZen infographic here). Chad Dickerson had 2.1 percent of Etsy by that time after 10 years of hard work (another nice EquityZen infographic here). In two cases, the CEO at the time of the IPO was the founder of the company, in one case not. Now, this is the point where the traditional narrative says: “Better to have 1 percent of a billion-dollar company than 100 percent of a zero dollar company.” But that’s actually a false choice.
The real choice is: Is it better to have 1 percent of a billion-dollar company or 10 percent of a $100 million company? Yep, if you think about it in these terms, it’s actually the same thing. With a bunch of major (and when I say ‘major’, I mean *MAJOR*) differences: the amount of capital you need to get there and, more importantly, the time you need to get there — not to mention the likeliness of the exit. Because just by factoring in time, the choice becomes much more interesting: Is it better to have 1 percent of a billion-dollar company in 10 years or 10 percent of a 100 million company in 5 years? If you ask me, I’d go for the second one any day of the week, because in the time I’d need to get an IPO I could maybe get 2 exits, and maybe not ‘just’ at $100 million, but at $150 million or $200 million.
I hear this all the time from early stage founders: I ask how much they’re raising; they answer, “(insert ridiculous amount of money here).” So I ask them why; they answer, “(insert casual reason disconnected from reality).” These are the same guys who approach investors saying, “With your money and your expertise, I can have a real advantage over the competitors.” Wrong, my friend. Investors (particularly nowadays) don’t want companies to depend on them to win. They want to bet on winning companies that can grow even faster with their involvement. After all, *you* are the one running the show. If they wanted a high level of involvement, they’d be running their own.
The best way to approach investors is, “Hey! I did ‘X’ and ‘Y’ last year with ‘W’ money raised. This year I’m on track to do 400 percent growth, but with your money and involvement I can target 800 percent growth instead. Interested?” Answer: Hell, yeah! And do yourself a favor. Do *not* raise a monster round if you don’t know how to deploy it to deliver on that growth. Do the math.
A friend of mine, about two weeks ago, was offered a term sheet for $9 million cash; she has a company that’s doing little more than $1 million revenue annualized. She turned it down and accepted a term sheet offering a third of that. Why? “I wouldn’t know how to spend it,” she said. Smart woman.
Because, you see, what lots of founders don’t realize is that they are the ones with tons to loose, not the investors. Investors know that 7 out of 10 companies will just plain fail. If they gave you $10 million and things didn’t really work out, how much effort do you think they’d need to pick up the phone and check with one of the big companies of the Valley, desperate for talent, to see who’s willing to hire your team of 10 people the week after? Last time I checked, for M&A purposes, a developer was quoted around $1 million (roughly five years of salary). They get their money back, you and your team get a nicely paid job. Could have been worse, sure; but could have been better also.
Now, I don’t think that VCs are evil. They’re just following the model they need in order to make the economics of their fund work. They need a Unicorn, period. Several, actually. Everything else is irrelevant. Jason Lemkin of Storm Ventures wrote about it here just over a week ago. And VCs are oh-so-good at selling themselves to you. So much, in fact, that nowadays everyone seems to be wanting to raise dozens of millions in funding to aim at reaching the Unicorn status. Everyone’s obsessed with this. But, hey, you are not them. Your economics are substantially different from theirs. Choose wisely. But if you go for that, be aware of what you’re signing up for.
Also (and this is my third point): The world has changed in the last few years. Not many realize it, but in a world where building technology is super cheap and acquisition’s channels are super efficient and entrepreneurs are starting more companies than ever, venture capital as an industry is kind of struggling right now. Not with the capital (that’s commoditized as well), but with how the industry works. The deal flow is becoming the issue: Either you cannot find/access interesting enough companies (if you’re not Tier1 or Tier2), or you have too many and so you’re churning through too many of them, and since you cannot invest efficiently, you’re missing out.
Only a very few players are keeping up with the pace. 500 Startups (over 300 investments last year), Y Combinator (around 200 investments last year) and AngelList (104 million raised online in 2014) are the ones that are investing at scale. The others? According to Mattermark, the most active VC last year made 20 investments. Twenty. I could go as far as saying that venture capital as an industry is losing relevance and becoming a “boutique industry.”
After all, that’s what happens when you invest in only 0.1-0.5 percent of the companies you see. Of course, it’s not reasonable to think that 50 percent of the companies an investor considers would be a good fit, but 5 percent does seem reasonable. Still, that’s 10-50 times the current rate.
The limiting factor is not the *quality* of the companies we’re talking about, since lots of them have good/great growth and are generating interesting revenue. Nor is it a matter of capital availability, since every industry report says we’re now seeing the highest availability ever. The bottleneck is in the *quantity* of companies that VCs can process and take a board seat on. That’s part of the reason why VCs are shifting toward bigger rounds at higher valuations. This is why, a few months ago, people were talking about how startups were getting trapped in a “Series A crunch”, where, after good seed funding, they weren’t finding investors willing to take on a Series A.
But I see this as being more of a problem for investors than for company founders Because the result of this macro-trend is that the good companies, the ones that deserve to exist because they are solving a real need for a real customer, don’t need VC money to survive anymore; it’s the other way around.
The good companies can get the funding they need more quickly by growing faster and/or by doing several smaller rounds and retaining more control and/or by leveraging crowdfunding campaigns and/or by opening a line of credit with a bank. They consider VCs to be a kind of cash-as-a-service entity, to be tapped into only when more efficient options are slower or not available. Lots of companies are already starting to go down that route. One example? Atlassian. It took its first venture round at $60 million revenue (Tom Tunguz has more here). If you ask me, it won’t be long before we see the first billion-dollar company that’s raised less than $10 million in funding (now, that’s a real Unicorn!).
What does this means for you as a founder? Easy: focus. To build a $1 billion company, you need to already have a $100 million company; and to build a $100 million company, you need to already have a $10 million company; and to have a $10 million company, you need to build something people want. So focus on building the $10 million company first, then when you’re there, think about the $100 million one. Only when you’ve built that $100 million one should you think about how to build the $1 billion company. And I’m not talking funding-based valuations, I’m talking revenue-based valuations, which is even more fun.
Oh, and don’t listen to people who say you shouldn’t worry about dilution. You should, a lot. Just do the math.
Armando Biondi is cofounder and COO of AdEspresso, a Saas Solution for Facebook Ads Optimization. He previously cofounded five other tech and non-tech companies. He’s also an angel investor in Mattermark and 25 more companies and part of the 500 Startups network.
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