There are many businesses like oil drilling and bio-tech that need a large initial investment or they simply aren’t feasible. Software businesses are not one of them. A small group of tech founders can work without pay for three to nine months and create a product that solves someone’s problem. They can create a profitable business with almost no expenses besides the opportunity cost of its own lost income.
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Experienced Valley investors and entrepreneurs perpetuate a myth that raising multiple rounds of VC at increasingly eye watering valuations and ultimately flipping to Google is what winners do. It’s productive, helpful, value creating and what we need more of. They also suggest it’s the surest path to mega-riches.
This culture is so pervasive that “Fail Fast” is a Valley mantra, one that would have real value creators like Bill Gates or the late Sam Walton predicting economic Armageddon.
I’m going to spend much of this article bashing investors and investment in software companies, but I will add that two of my own investors are also the finest mentors I’ve ever had. One in particular has always told me that when I’m in doubt, just write the software. The most effective thing you can do as a software company founder is get down and code. No one else is going to create your product or make it more valuable.
Raising money is a massive amount of work, very distracting and emotionally draining. It distracts from creating the real value of your company which is your product. Once you’ve raised a round of funding it actually feels like you’ve accomplished something. You kick back and take a break because all that negotiating, signing and wire-transferring felt like work. Three months later you may actually begin to hit your stride in product development.
In my own company, we never really focused on creating profitable products until we burnt through all our investment money and decided we weren’t going to raise another round of funding. From that moment forward our culture completely changed. We realised we were in it for the long haul and since that day we have been completely focused on solving customer problems and creating sustainable solutions that are worth more to our customers than the dollars they exchange for the service.
If you do raise money, once you’re working on your product you may have one of those dreaded angels-who-want-to-play-entrepreneur on your board. I’ve never experienced one first hand, but more entrepreneurs seem to have them than not. It’s debilitating for a young company with a young inexperienced founder to have the guy who wrote the check giving you product input. I’ve seen entrepreneurs reduced to tears by these kinds of investors and companies destroyed before they even get off the ground. One Seattle founder told me that his angel investor fired him and appointed himself CEO.
Then there’s the question of, not if, but when you’re going to raise another round of funding. Many west coast entrepreneurs raise angel money from VC’s who pretend to be angels. What the VC is doing is buying an option for the next round which is what really interests them. They want to invest in a big business with at least a 9 figure exit. All mentorship and guidance is focused not on business fundamentals, but positioning the company for the next round of funding. Closing a B round is the definition of success. VC’s become the target market. Customers are a necessary evil and a distraction that must be tolerated until the next capital infusion.
Finally, the biggest down side of raising VC money is the kind of exit they’re counting on. The IPO market has been dead in the USA for the last decade. A few companies dipped their toes recently, but market volatility has caused a pullback with the highest profile being Groupon’s cancellation of its IPO. It now claims it will go public in November, but I doubt it will materialise. The exit strategy for VC portfolio companies for the last decade has been acquisition. Consequently, if you raise VC money you’re almost certainly building to flip, whether you like it or not.
A company building to flip has a culture that is doomed to fail. They know that one day in the not too distant future, someone is going to take away all this pesky software and these pesky customers and hand them a big check. Often the assumption is that the acquirer is not going to value the company on revenue or profit, but rather how strategically interesting it is. The company writes blog entries that show how sexy its technology is and how smart its employees are. They’ve heard that Google acquires companies at US$2-million per engineer, so they get very good at recruiting and beef up that headcount.
Many Valley based VC funded companies don’t confront the reality of sustainable business success until they’re about to run out of money and they are turned down for a subsequent round of funding. That means they never have the opportunity for healthy honest business evolution until they’re about to die and have a firmly established culture of dependence.
As another great mentor once told me, money is a drug. Once you start paying someone, they will keep coming back for more. Investment dollars are highly addictive and once you’ve taken the first and second round of funding, there is no turning back and it’s often impossible to wean yourself off investment dollars and shift to surviving on revenue and to build using retained profit.
But that’s in the parallel universe we call The Valley.
In most of the rest of the world, especially in BRICS countries, entrepreneurs build companies to be profitable. They have the bare minimum of initial investment capital which clarifies the mind and cuts to the core of value creation. Here are the rules the real world lives by:
- If you can bring in cash, you get to live. If you can’t, you will die and a business that deserves to live will take your place and consume your resources.
- If your business earns buckets of cash, you can afford to buy the best talent and you get stronger. If you don’t have cash, you can’t hire and you get weaker.
- If you are profitable you can use that to grow your business.
- If you’re smart, you will create even more profit in a virtuous cycle.
Businesses are valued on Net Income or how much Net Income they will earn in the near future, or how much additional income will be generated by combining them with another complementary business.
“Sexy” or “Cool” have no meaning in this world. Because there is no excess of investment capital, jobs are harder to come by, so successful companies find it easier to hire top talent and talent acquisitions are rare or non-existent.
Buzz words and phrases describe companies that make more cash than others, not what some famous VC recently invested in and is now pumping before he dumps.
The jobs that these companies create are real and sustainable and their employees are paid with earned money rather than speculative dollars.
The sense of urgency that a dire need for cash creates is the most powerful driver for useful and sustainable innovation. Use it to your advantage. Avoid raising money and don’t fret if you don’t have the option. Rather than an investor, find an experienced entrepreneur to be your mentor and focus on building a sustainable, profitable business.
