Excerpt from Episode #13: Addressing criticism of 37signals (Part 1 of 2) of the 37signals Podcast (transcript):
David: That’s the main push-back that we have is not that venture capital is bad; It’s that venture capital is bad when applied to businesses that do not have excessive capital needs. Because then it creates all these sort of distortions, where the money has to be spent and it’ll have to be spent on, well, hiring more people, because that’s really the one major expense that web startups have.
And then you get into all these sort of problems where you have a vastly over-staffed startup, because that’s what you have to spend your money on, so that’s what you will spend your money on. And you get, oftentimes, big, crufty, overbuilt products, instead of just focusing the same idea on a much smaller team that doesn’t require millions of venture capital and can get out the door with something simpler and build a real business around it.
Jason: Maybe once you have a success, once you have customers, once you have a track record, once you have a clear path, and then you feel like, for whatever reason, you need more money to do something else, then, OK, maybe it makes sense for some companies. So expanding operations, once you actually have operations, may make sense.
But you don’t expand operations upfront when you have nothing. You first build operations. You first build for a few years. You first build some profits and some customers before you want to do that.
David: Would you go out and start, let’s say, 500 McDonald’s before you even know what the menu is, before you’ve even designed your hit burger yet? No, you wouldn’t. You would run one franchise until you’ve really honed how that thing is going to work, how a single store can be profitable, can make a space for itself.
Greg
on 13 May 10What about pharmaceuticals?
VC is great for this market – wouldn’t you agree?
Since research to find a cure is extremely expensive. The money from VC is being spent to develop your “menu”, using the McDonalds analogy.
JF
on 13 May 10Greg: Pharma is different from software. We’re mostly referring to software and services businesses. Pharma certainly requires up front investment because it requires labs and expensive, controlled environments. Software requires a laptop and an internet connection.
markd
on 13 May 10... indeed. As stated in the first sentence of this post!
“That’s the main push-back that we have is not that venture capital is bad; It’s that venture capital is bad when applied to businesses that do not have excessive capital needs.”
Harry DeMott
on 13 May 10Doing a VC round is not a whole lot different than going public – all of a sudden your priorities change dramatically in terms of what you need and how you go about your day. As a former research analyst at an investment bank – I’ve counseled companies never to go public – it was simply more trouble than it was worth because the company did not need the capital.
I would, however, modify your original statement for companies that want to grow faster than their internal cash flow would otherwise allow.
You guys have a very nice business and seem to have a fairly reasonable view on how you want to run your lives. But now think what you would need to do if you wanted to quadruple your sales overnight because you weren’t happy simply being a very successful company with the owners in charge of their lives – but you wanted to take on Microsoft and were willing to make that trade off. Then VC or some other form of outside capital might make sense.
The truth of the matter is, as soon as you take in any capital from anywhere – you are not only working for the government and yourself (hey somebody has to pay taxes) – you are working for your capital provider as well.
Depending on just how strong willed and independent you are – this just may not be for you.
KD
on 13 May 10a couple of years back i got a call from a very large mega/ too big to fail bank who i have a credit card with. they called to tell me that they were increasing my credit line to about $250,000. the thing was i didn’t NEED that money and them giving me that money would mean that i would be enticed to spend it AND pay it back to them. to me, that is the same thing as unnecessarily taking venture capital. if you need it for something, take it. don’t take it just to have it because in the long run you put your organization, and its control, in the hands of other people.
Berislav Lopac
on 13 May 10The problem is that - especially recently - VCs seem to be preferring precisely that kind of startups you’re talking about: Web services, mobile apps, stuff that need very little investment up front. Think Facebook, Twitter or Foursquare.
No one seems to be any more interested in real software innovation, i.e. companies that need years of funding before makind a viable product based on a completely new technology (a good example: Google).
Noam
on 13 May 10Though this is 100% true, I think the problem when seeking investment too early is not so much that you may not have a need for the money or that it’ll be wasted. I think the issue is that you’re much less likely to grow a profitable business if you’re in the mindset of raising funds and seeking investments.
For example you won’t look for smart and elegant solutions to the problems you are facing – you’ll think that maybe you should throw more money at them. You’ll think about how you’ll raise the next round of funding instead of how to build a unique business.
I don’t know if you guys accept links here in the comments – do you? If you do, here’s a short post I wrote on this topic: Grow a profitable business – don’t raise funds
Matt
on 14 May 10“But you don’t expand operations upfront when you have nothing.”
@ JF: This is probably the single most important lesson an entrepreneur needs to drill through their skull.
I have been persisting at it since 2005. I have yet to take VC money (though at times it’s tempting) and turned down a purchase offer (even more tempting).
It’s a real joy to build something. And, this may sound odd, but I have enjoyed watching my growth “normalize”. It sounded neat to say: “we grow 900% last year”, but when you go from 15 accounts to 150, this isn’t that big a feat. But, when you’re growing at 25% several years later with the bigger numbers, that’s the “stuff” right there.
I was practicing Getting Real (& Rework) principles before I read it, but the book, your journey, and SVN have really codified things.
Thanks, JF & DHH (and 37 Signalers all).
Matt
TJ
on 14 May 10Just out of curiosity—how are you doing your podcast transcripts? In-house, or using a third-party service?
ML
on 14 May 10TJ, we are using Casting Words for the transcripts.
Tony Wright
on 15 May 10Two concerns that I have with your concerns ( :-) ):
1) Having money doesn’t force you to spend it fast or recklessly (I have the same criticism with your gripes about workaholics). Scarcity is not required for intelligent allocation of resources—but it might help if you’re undisciplined. Smart founders spend carefully, because every dollar spent shortens runway. Smart VCs encourage careful spending until there is a clear path where you can turn $1 of spending into a $1.25 in profit.
2) JF, you’re on the board of Groupon, which has taken HUGE piles of VC. Do you think they have a clear path? Or in other words, do you think their business will change substantively (other than in size!) in the next 36 months? I bet it will.
As David says, it’s a bit of a lottery. But given the unlimited upside, it’s one that makes sense for VCs (perhaps not founders, though!). There are all sorts of startup games to play. You guys (wisely, I think), advocate for the casino equivalent of low-stakes poker. Folks who take smallish angel rounds are getting into high-stake blackjack country. Folks who take big rounds are getting into huge-bet roulette. The last one isn’t my game, but the winners sure look happy. ;-)
JF
on 15 May 101. Tony, when someone invests, they expect you to spend that investment. That’s what it’s for – to spend. It’s not there to collect interest. Having other people’s money to spend, and a directive to spend it, typically means one thing: Companies hire more people than they need. Hiring people is the fastest way to spend money. Plus, hiring feels good so when you have the money to spend, hiring is typically what happens. Too many people leads to inventing work to do or spending time on things that don’t really matter just so you can keep your staff busy. Some may say all the work they are doing is absolutely necessary, but I bet in most cases at least half the work could be cut with no negative impact. That’s a generalization, yes, but I’m OK with it.
2. I’ve been public about my feelings about Groupon taking more investment: I’m against it. Andrew, the CEO, knows how I feel. One of the reason he invited me to serve on the board was to provide an alternate point of view. I can’t comment on Groupon’s specific plans other than to say I think they plan on continuing to kick ass.
Tony Wright
on 16 May 10Had to come back for a followup because I saw an awesome tweet: “Fewer than 15% of venture-backed startups are operating 3 years after initial funding. ~Harvard Business Review” http://twitter.com/dharmesh/status/14067731416
Yikes! There’s your lottery. I imagine that a small subset of the 15% that survive 3 years actually see a significant payout for the founders… Would love to see stats on that.
Yeah, I hear you on the “pressure the spend”. FWIW, we took a smallish Series A and have received no such pressure (from investors) and have kept our team small (despite the temptation to hire)... So it can happen. I think there’s a leaner mindset nowadays, especially with the smallish Series A investments that are happening nowadays.
Anyhoo, thanks for the reply, and the info on your Groupon stance (didn’t know that!). I worked a contract briefly with those guys before Groupon spun up and I think they have a freakin’ outstanding team.
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