Investment increases your risk | Hacker News Reader

Investment increases your risk

swombat.com

194 pointsswombat113 comments

This is the crux of the argument:

"If you raise funding, however, it cuts out a number of the middle options. VCs will definitely want an exit, and if the exit is too low, this can turn a fairly decent success into a relative failure for the entrepreneur."

However, in my experience (which is now fairly extensive), this scenario is a vanishingly rare one.

Raising a lot of money can certainly be dangerous, but not for the reason Daniel thinks. The big danger in raising lots of money is that you'll spend it-- that you'll let this pseudo-success (with investors rather than customers) go to your head, ramp up your spending before the company is ready, and then put yourself into an impossible position later where you've burned through the money and need to raise more but haven't achieved the results you'd need to do so.

In other words, venture funding is dangerous in the same way any power tool is.

My (recent) experience with friends at startups suggests that in accepting venture capital and giving investors board seats, you're going to be pulled hard towards ramping spending: your board will want to see things like a formalized marketing team led by an experienced VP/marketing, and you'll quickly find yourself having to argue against spending more money. It's not just that funding goes to your head.

Also, while I defer to your experience, maybe the vanishingly rare "marginal exit" scenario Daniel talks about was once more common; the two companies I was at prior to this one both faced it. Or is it possible that it only appears rare because nobody entertains the idea of a marginal cash exit for a VC-funded startup anymore, knowing what a headache it'll be?

My (limited) experience with funding is the opposite. Rather than request an experienced head of marketing, they wanted an experienced CFO to be the adult in the room.

I think the question of funding comes down to, "Would you put this on a credit card with a 30% interest rate?" If the answer is yes, and you don't have the credit card available, then funding is ok. The reason is that you're expecting a return much better than 30%. If funding can give you a product edge so that you're winning 5 enterprise deals out of 10, rather than 2 out of 10, the numbers will probably make sense. If funding allows you to do a marketing campaign with real analytics and AB testing that will change your growth rate from 10%/month to 20%/month, it will probably be worth it.

Yes, it's true a lot of VCs will encourage you to spend faster than you should. I warn about this in essays and in a lot of individual conversations with founders. But fortunately they can never do more than encourage, because founders almost never give up board control in funding rounds nowadays, at least not in the US.

As for marginal exits, I think the biggest reason they're rare is that there is not that much demand on the buyer side. There's lots of demand for HR acquisitions of failed companies, and there's demand for high fliers, but Facebook and Google et al are not looking for small, moneymaking businesses.

This is something I've wondered about - I hear people warning about investors pushing them toward an end they don't want, but what leverage do they have?

They don't have the same kind of board power they used to, but they're still very influential. They are often more experienced than founders, and also, being older, more authoritative. And much of their advice is good. Especially the best investors, some of whom are really smart. So founders rightly start to rely on their advice.

The catch is that founders' and investors' interests are not always aligned, and when they aren't you can't trust investors' advice quite as much. But the two types of cases aren't sharply differentiated. Which means to avoid being misled by investors you have to be able to judge precisely how misaligned your interests are in each situation, and discount their advice by exactly that amount. It's a subtle problem.

> but what leverage do they have

I thought he meant "what leverage do the founders have?". Not sure though....

However, assuming that he did mean "what leverage do the founders have?", I would say that they are the boots on the ground and can very much scuttle anything that the investor wants them to do. The moment founder's interests are not aligned with the startup, it is doomed. I guess an investor can help them succeed but can't stop them from ruining it.

Disclaimer: pure speculation, I have no experience of being on either side of the table.

So the leverage is either official (maybe they have a board seat) or (more often) social - founders feel either that they SHOULD listen to their investors because they're older and more experienced or that they have to for various reasons. Makes sense.

One thing I always forget about being a founder is that you're constantly reaching places where you have absolutely no experience - and yet you're still in charge. The Collison's for example are younger than me, and I'm pretty young, yet they continue to run a company that is growing at an extraordinary rate. Must be pretty interesting.

They have a lot of unofficial leverage, particularly when it comes to future fund raising, venture debt, and even acquisitions. It's much, much easier to raise an A-round when seed investors are helping, and presumably the B-round is much smoother when the A-round firm is actively helping.

"but Facebook and Google et al are not looking for small, moneymaking businesses."

There are for sure many companies (that are not google and facebook) out there that would be interested in acquiring "small, moneymaking businesses".

A business that makes money can be sold. Period.

I've both owned and sold (both that I've owned and for others) "small, moneymaking businesses".

Part of the issue really is most likely:

a) lack of effort in trying to sell the business (making the assumption that nobody will really buy it or that it's not worth the trouble) or

b) the people who work at the business that we are referring to here (startup lottery) perhaps won't stick around after the company is acquired. So the asset has dubious value since the most important employees won't be there post acquisition possibly.

I tend to think that it's more "a" than "b". People are lazy and are looking for an easy route and if they don't find that easy route or have no evidence that others have done it any other way (because of their lack of experience in general business) they assume it's not even worth it to try.

Of course if you want to remove the word moneymaking from the statement....

As a recent example I was trying to help someone sell their "small moneymaking business" so I sent a cold email to the head of Rackspace. I got a reply the same day and they assigned people at Rackspace to consider the request (can't say what obviously). It didn't take investment bankers it didn't take business brokers it simply took identifying an obvious target and sending an email. If the email didn't get answered (it did) I would have sent a postal letter or fedex stating the opportunity. Did the same with a reality tv star presenting an opportunity. Same thing got a reply and a deal was done. (I guess I write good emails?) And that didn't even take effort. Of course there are emails that have not resulted in anything obviously but that didn't make me stop trying to do deals. Most people get rejected and don't understand the value of plugging away.

> A business that makes money can be sold. Period.

This should be further constrained to "a business that makes money in excess of market-rate salaries for all personal and merger overhead can be sold".

Solid programmers in the Bay Area pull over $250k annually in total comp (salary, bonus, and equity); however, only a few companies can or are willing to pay that.

You can easily find yourself getting better acqi-hire offers (HR hires) from Google,Facebook, et al. than offers to actually buy your company by other players. And since you need to "stick around after the company is acquired", it is not uncommon for the acqui-hire to be the best exit for for companies pulling < $1M/year rev (esp. true with VC backed companies where liquidation preferences are present).

Don't see your email address in your profile. Are you open to being contacted? Would love to connect for advice as we are looking into options for sale of our small profitable business (~$3M revenue in 2013; $5M revenue run rate). Please email me at libertatis at gmail dot com if you wouldn't mind having a quick chat!

Instead of financial loss, I'm more afraid of losing the IP, company, everything I've made prior to my investors even joining, because the investors or their successors suddenly feel like kicking me out someday.

Losing IP used to bother me, but in hindsight turns out not to have mattered.

The fully integrated system you built failed in the market; its value is illusory (if you got to keep it and redeploy it, you'd probably lose in the long run).

The components of that system probably aren't lost to you at all. First, nobody cares about them anyways (VCs aren't going to chase you down for repurposing some scheduling library you built for your restaurant app). Second, while you operate the company you always have the ability to open-source them as you go. Third, once you know how to build a component, it's pretty easy to rebuild it.

You're probably right about the IP and databases not being completely trapped, in practice.

What about non-competes though? Could I really start a directly-competing company immediately afterwards? After all, not all startups fail just due to having completely worthless products, there could be many other reasons.

What non-compete? Are those common on VC deals? There weren't any when I took funding, but that was awhile ago.

Non-competes would likely come either when you left the company in exchange for some unvested options, or after an acquisition.

Non-competes are largely unenforceable in California.

Employment noncompetes are unenforceable. Other kinds are. A noncompete you accept in exchange for an investment is likely to be enforceable.

Wouldn't that depend on the IP? If you pop up later making significant money with your source or patents, I'd assume there would be a lawsuit in your future.

Thanks for sharing the view from where you sit, that's insight that's hard for most of us to pick up on our own. Do you know of or have any shareable data on venture backed founder returns?

What's your take on if funding shuts down a "pivot to a lifestyle business"? I've always looked at the outcome venture most strongly closes down as "$300k a year pseudo annuity." Basically the kind of business returns profiled in the $100 Startup book.

I think your experience is too biased to be useful for people outside of YC/Palo Alto/California/America. Even besides the caliber of people that get into YC, the immense network and support system as well as caliber of investors probably makes your advice less relevant to most startups.

YC/Palo Alto/California/America/Continental North America/Western Hemisphere/Terrestrial Earth/&c

Well yeah, I put them in that order for a reason. It shows how pronounced his bias is. There is a world of difference starting a startup in Greenland than in Virginia, and a world of difference from Virginia to California. Most people reading pg's advice are going to take the wrong thing away from it.

> However, in my experience (which is now fairly extensive), this scenario is a vanishingly rare one.

Your experience mostly corresponds to Boston and Silicon Valley, though, correct? I do not have your experience, but I read a lot and keep my ear to the ground, and, not living in those areas myself, got interested in the "micropreneur" idea - stuff like what patio11, Rob Walling, Peldi (Balsamiq) and company are doing. The numbers - at least those I've seen - don't generally seem like they would be a win for investors looking to put millions into something and get multiples of that back. However, at a personal level they seem to be doing very well for themselves. It strikes me as a model that is perhaps more applicable to "the rest of the world" where the ecosystem is not, nor likely ever going to equal that of Silicon Valley.

Of course, I do not think there are any recipes or hard rules for any of this: some companies need VC and need lots of it to be able to do anything, because they've got grand schemes that change the world. Others don't and would be better off without the distraction.

One thing which might skew your statistics, is that taking VC funding or going to YC is itself the result of wanting a large success being your mindset in the first place.

In other words, it's true that investors don't necessarily have leverage over founders, and I'm sure the scenario that Daniel describes is just as rare in YC as you say it is.

But the reason this is true might be that the kind of people who go to YC are also the kind of people who want to take a 1-in-a-million shot at big money, rather than taking more conservative odds for less money. And one of the reasons this is true, is that founders don't understand the statistics and the risk profiles of their options, or in many cases don't recognise that they even have options in the first place when choosing what type of business to build.

Daniel's meta-point about founders being able to choose which kind of business they will build, including choosing it's risk profile, is something I hope more and more founders get exposed to.

That could be. At least at YC there are comparatively few misunderstandings about what's expected of companies that take various kinds of investment. But if there are people out there who are unclear about what kind of company they want to create, or take money from investors without understanding what the investors expect in return, I could imagine there would be trouble down the line.

"However, in my experience (which is now fairly extensive), this scenario is a vanishingly rare one."

Wasn't there just recently a link[1] on HN about a startup that was bailing (and returning the remainder of it's VC) because it was only growing at 20-30% per month?

[1] http://blog.ridejoy.com/from-carpool-to-deadpool-ridejoys-st...

If they were truly growing consistently at 20-30%/mo they should never have quit. 20%/mo is almost 9x a year. That's a fabulous growth rate. I'm guessing they meant they grew at 20-30%/mo for a while and then things slowed down.

I think of most VCs as "money brokers" or "money salesmen" rather than as capitalists or investors. A company taking in $100 million in venture capital is basically enabling the VC partner(s) to earn $2 million a year annuity until an exit. That 2% annual commission (that's what I call it) on every invested dollar is a substantial incentive on the part of the VC to push more and more money on companies that a) may not need it b) would be unwise to spend it.

I don't see any justification for the 2% on ever-larger rounds of investment. The work VCs do on a $100 million investment is not 100x more than the work they do on a $1 million investment. I hope that model gets disrupted!

That's true of mediocre VCs, but it's not true of top firms like Andreessen-Horowitz or Union Square Ventures. Those guys do a lot more than write checks.

Do you know of any hacks to minimize spending?

I ask because given the funding climate right now, it seems foolish not to raise more capital on great terms. It's especially true for first-time founders, who don't have an intuitive sense of how much the startup will need. (Or personal assets to float the company, if needed.)

It's also not clear how to maintain a sense of urgency or frugality when other startups are paying crazy salaries and throwing huge parties.

Perhaps this is less about spending money, and more about staying focused.

Don't hire people. That is where startups spend all their money.

Hiring too fast is doubly constraining. It increases your costs, and it also makes it harder to change direction.

Outsource tasks that cost human resources but are repetitive and easy to systemise. For example, you can outsource market lead generation, social media posting and other data entry for a few dollars an hour. Or get interns (be careful about the management cost of interns that will only stay for a short time).

"Most first-time founders are broke." (...) "new founders should be looking to decrease their risk, not increase it" (...) "And therefore, first-time founders should almost never take funding."

I am a first-time founder, I am broke and I am taking angel money. Because I am broke! In his line of thought, the OP is not considering "broke" as actually broke. He is imagining some kind of "broke" where you still can pay your bills, your food, your rent.

No, I am broke. I have two options for January/2014: (i) get some angel money, aka, be paid to work on my own company or (ii) get a day job and turn my startup on a side-project, aka, killing its chances to be something profitable.

This is not about risk, i am broke. No bootstrapping options for me anymore, this ship has sailed. So, angel money is a much better option. If I make a success out of this company, even if this does not make me rich, now I am a experienced founder, with a track-record and, some money. I can bootstrap my next company with far less risk and even fundraise on much better terms. But now? I am broke, that's the point.

Option 3: Start a business with a business model that allows you to generate revenue in month 1. It sounds like you're using the funding as a cushion to protect you from having to build a profitable business RIGHT NOW. See this article http://swombat.com/2011/12/8/investment-cushion-springboard

With option 1, you're still going to be broke, but in a year's time, or whenever your money runs out and you realise you still don't have a business that makes money.

Nothing focuses the mind on finding revenues like being broke and needing to make the rent.

(I've been there. I was broke when I started my second business. We raised funding. Three years later when we ran out, I was still broke. I am fairly convinced that if we had raised no money we would have been much more likely to succeed, since it would have forced us into tangible, serious discussions with our potential clients immediately, and forced us to learn to sell right away)

  Nothing focuses the mind on finding revenues like being broke and needing to make the rent.

True. That's why I found an angel. It's easier than build a business. One step at a time.

I completely disagree about "Nothing focuses the mind on finding revenues like being broke and needing to make the rent." I know that a lot of people out there believe in this "desperation leads to solution" mantra. But I don't. I work much better and I am much more focused when I don't have to worry about bills.

I started to sell my product from month 1, but wasn't able to generate revenue from month 1. I have a SaaS for restaurants, the sales cycle is longer than a month, no restaurant (around here) close deals at the end of the year - this I learned from experience, but also from successfull and experienced entrepreneurs from the same market; also advised by these successful founders I am offering a 3-month free trial for the first clients. The advice actually was "you will only charge after the 10th client, you need social proof first of all, so give your product for free and then charge after the 10th early-adopter."

So, there is no way I can be profitable before March or April. Ok, maybe I am no sales wizard, maybe I am not good enough on this founder thing. But the point for me is, I am broke, and I already started my company, and I can't make it profitable. As I can't choose option 3 "go back in time and found another business" and I am not ready to quit this business, I will take funding.

So, there is no way I can be profitable before March or April. Not with this business, for sure. If you have a business idea that requires many months or years to get off the ground, and you don't have the resources to sustain yourself during that period, though, I'd argue the idea is out of your reach: http://swombat.com/2012/1/19/idea-reach-cofounder-myth

In your position, I would pick a different business idea.

In his current position you would advise towards starting over with different business idea from scratch. One that would generate money from day one and need zero money to start.

Yeah.. I'd say take the funding.

Or Consulting/Freelancing. It's very much possible.

That is what I am doing currently to support my start-up. One steady client that pays well and is willing to work with a somewhat flexible commitment from me at about 10 to 20 hour per week. And with careful spending that will pay bills for my family.

I did some freelancing. A two-week job paid my November bills. It was a good emergency revenue, but it is a palliative solution. It is hard to find such jobs, it is unpredictable and also distracting.

I still prefer the angel investment.

From my experience, being desparate pushes you extra, true. But you hit a wall, since you've just spent a lot of your time chasing urgent and important instead of not urgent and important, which is preferable long-term strategy.

I could make a house building analogy here probably.

In a Saas, you are basically doing custom application development for your first few customers. If your customers won't pay $100 a month for that, I would be concerned about business validation.

Another way to look at this situation is that in the absence of revenue, you may be kidding yourself about the viability of the business. If you can't generate any cash from it, how do you know it's a product/market fit, or that you're capable of executing on it?

You will eventually come to learn that your time is precious, and that wasting it on an idea that can't be made to work is worse than failing to make one (of many possible) viable ideas succeed.

This is something I worry, but I am still convinced it is not time yet to quit or pivot. I have 5 clients: 3 are on a 3 months free-trial, 2 are paying about $80/month, starting in January.

For some context, my product is a loyalty program for bars and restaurants based on Facebook's check-in. I talked with 50+ restaurant owners, and social proof is very important. But i also learned that no restaurant is totally satisfied with my competitors' products. I learned where I need to perform (final customer's adoption, as it is a B2B2C product). And I am testing my premises on these 5 clients. These next two months will be crucials to validate my business. I actually put a hold on sales to take good care of these clients. If in two months there are willing to pay for it and let me put their logo and cases on my marketing material, then I have a business. If not, then it is time to quit (or pivot). Either way, I still need a month or two, at least, to know if it is a good idea (or if I am good enough executing it). So I am taking this angel money to validate a promising idea. Sound exactly what angel investment is designed for.

People who haven't been broke recently often forget what it is really like. I mean how can you be worried about something as ethereal as investment risk when you can't pay your bills. This is premature optimization, there is no proof of value yet. Take the money.

"Nothing focuses the mind on finding revenues..."

So I spent months attempting to chase revenue (i.e. looking for the next thing that might make money now ...) instead of building the business I wanted.

"Nothing focuses the mind on finding revenues like being broke and needing to make the rent."

Research shows that the cognitive load associated with being broke amounts to a loss of one standard deviation in IQ. The mind is focused all right: only on making the rent and on nothing else, and under no circumstances on anything like starting a business.

I've heard the same thing, but do you have a reference for this?

LMGTFY:

Anandi Mani1, Sendhil Mullainathan2, Eldar Shafir3, Jiaying Zhao4. Poverty Impedes Cognitive Function. Science 30 August 2013: Vol. 341 no. 6149 pp. 976-980 http://www.sciencemag.org/content/341/6149/976

http://www.theguardian.com/science/2013/aug/29/poverty-menta...

"Start a business with a business model that allows you to generate revenue in month 1"

It doesn't seem to me this is very realistic.

My impression is that building any kind of serious SaaS is going to be at least a 6-12 month project for a single developer.

Even ideas like blogs with affiliate marketing revenues probably take about a year to generate enough users to make sufficient money to support oneself and simple pure ad supported sites seem to require at least 100K+ users to make money (ie with RPM's around $1).

Is it really possible to start a software/online business that will earn significant revenue in 2-3 months ?

EDIT: Excluding consulting/freelance work of course.

SaaS is not the only business model out there...

It's entirely possible and very realistic. I built a SaaS product in the equivalent of about a 7-8 working days that 4 weeks in had $1000 in MRR and 8 weeks later is double that.

http://joshpigford.com/baremetrics-stripe-analytics

It's about solving problems that businesses are willing to pay for. Doesn't matter how good the idea sounds. Only matters if businesses will fork over real, tangible money for the problem you're solving.

"Start a business with a business model that allows you to generate revenue in month 1."

Funding is for companies who want to be big/great. Most big/great opportunities have a cash-intensive front-end that scares away most entrepreneurs. It's not a "cushion" - it's a MOAT. Funding is the boat that gets you across it. There are certainly exceptions, but I don't think it's fair to assume he's "using funding as a cushion".

I've noticed a few people say they've just gone out and found an angel instead of working freelancing/etc. during development. Out of curiosity - how do people go about this? Do you meet people through your existing contacts? Do you search on the internet? Do angels generally need to be people in the same country?

Angels are - almost by definition - very personal relationships. As such, I would think that most angel investments are done through your network.

I don't generally disagree that first-time founders should think carefully before raising venture capital, but the example used to back up this statement is misguided on two counts.

1. It implies that your VC partner(s) can decide to sell your company without your wish. For the size of business mentioned here, this is unlikely. E.g. Even after we raise our next round (Series B), an acquisition can't happen without the founders' concent.

2. 2x liquidation preferences are not standard these days. I don't know anyone who's raised on more than 1x.

I think the author has a relatively refreshingly fair view on raising capital vs. bootstrapping, but the misunderstandings I've highlighted are typical. For any aspiring entrepreneur, I can't more strongly recommend you do your homework before deciding that raising venture capital is not for you.

IMHO, even the 1x liquidation preference is a clause that screws up the entrepreneur and the company. If I raise $5m in year 1 and end up creating a company after 6 years worth $5m in equity value, the VC should take the -50% hit, but they should not be allowed to screwup the entire cap table, exit/liquidity options simply because the VC went in at a high price.

This 1x-2x liquidation preference clause is unheard of in any other asset class, be it debt, mezzanine, etc.; and it's not even used by investment funds, private equity, and other professional investors.

Then don't take money with preferences attached. Good luck, though, because preferences correct an incentive imbalance that is extremely concerning to venture capitalists (that you'll happily accept an outcome that will lose money for the investor).

What do you mean with "preferences correct an incentive imbalance that is extremely concerning to venture capitalists"? and why don't other investors in other asset classes experience this "incentive imbalance"?

Because investors in other asset classes aren't investing in individual entrepreneurs with barely-established businesses whose lives could be substantially improved with low single digit millions of dollars, where the returns implied by such a reward would also imply a total failure for the investors themselves.

It's a principal/agent problem. In taking investor money, operators assume some responsibility for generating returns for them. Nobody would invest without the promise of those potential returns. But operators incentives are, absent preferences, actually not aligned with their investors: they would be better off not trying to generate the returns they promised to try to generate, but rather to hew to a conservative strategy that is almost certain not to generate returns but will ensure a golden parachute for the operators.

Preferences correct for this problem, sometimes elegantly: they say "you can take this money to try to generate the returns you promised, but it would be irrational for you to use it to build the small exit you promised us you wouldn't be aiming for."

"principal/agent" dynamics are no different for other asset classes, and a liquidation preferences is by no means the best way to align interests. liquidation preference clauses assume investors have invested at a price where they see considerable upside in a business/market. Unfortunately, investors, like all other humans make bad judgement calls, it can certainly be the case where an (price-wise) aggressive investor prices out an entrepreneur/company, whatever the funding round, be it seed or Z round. Having said that, it's the entrepreneurs call to learn and know when to avoid these risks. In the startup world, caveat emptor applies to both entrepreneur and investor.

This comment isn't responsive. What is the other asset class in which investors sink large amounts of money into 2-4 individual people with no established business and nothing to lose? That's where the principal/agent problem comes from. PE funds do not have the same problem.

"2-4 individual people with no established business and nothing to lose" is quite a broad-brush to define how startups and entrepreneurs are. I don't think that $200k qualifies as "sink large amounts of money". My point regarding liquidation preference is that this clause is prevalent across all funding stages, even when the company has an established management team, considerable cash flow, etc. "PE funds do not have the same problem." I have disagree with that statement, private equity funds do have big principal-agent problems (family owned businesses, first time CEOs, strategy, capital structure, etc), and every time we come across these they are solved with veto rights over capex, acquisitions and capital structure, but definitely not pricing other shareholders/management out of the cap table.

This is silly. A $200k deal doesn't come with preferences and if it did it wouldn't matter anyways, because $200k is a small fraction of even a marginal exit.

If you take a number which is for argument sake and call it "silly", that is fine by me. To argue that liquidity preference clauses are the ONLY method to avoid the principal-agent problem (and that's not the only reason it's there in the first place), both you and I know that there are other, more entrepreneur friendly, methods to go around this issue.

The other way to correct for this problem is founder cash-outs, which require some negotiating leverage but solve it even more elegantly. Rather than saying "We're worried that you'll take a small exit that would be great for you but a disaster for us", they say "we'll pay out that small exit we're worried you'll take, because you're being offered it anyway, and now you have the same incentives we do to shoot for the fences because you're already independently wealthy." It aligns incentives almost totally, and is viewed as a benefit rather than a restriction by everyone involved.

If you got $5M investment and then sold the whole business for $5M then what exactly did you (as a founder) contribute?

And if you did not contribute anything, then why do you expect to get paid?

Taking funding is ok as long as you write your own rules and the other party agrees, of course they need to be somewhat reasonable. I also agree that having some revenue prior would be much better, that way you know what you can expect in a month, two months, and so on. Of course, those are just business predictions, but these predictions can be very useful when taking a loan of some sort. Then you can actually do something like "I need 50k for 1 year @ 20% interest, here's my revenue, I will grow this business to x", write a 12 month contact and off you go. Do not give shares right off the start. There are people out there that will want shares, there are people that will give you a private loan, there are no banks that will do that (haha), and of course there is family, friends etc. Just don't f-it up if you're going this route.

I have been working for myself since 17-18, 10 years of self employment. I have been in the food industry (disaster), construction and web. I have had every single position at a company you can image. Just now, I think I can run any business (of course with more failures). I am just not there yet, taking my time, we'll see what 2014 has for me.

This is an article about return, not risk. Taking VC money in no way increases your risk—you're not personally liable for that money and a failure still ends with $0.

I'm not sure whether the change in return value matters enough to avoid VC money, but I do know that taking VC money absolutely 100% decreases personal risk.

If you bootstrap, you're investing both your own time and your own money. If the company fails, you've just lost a lot of time AND wiped yourself out financially. That's a huge risk.

If you take VC money, you're only investing your time. Yes, you might make less money off middle outcomes, but you've also eliminated all financial risk to yourself. There's no way that you walk away from a venture-backed startup with less money than you had going in.

I don't think anyone should consciously be advising the first option (bootstrapping) to anyone who is risk-averse.

This is an interesting conversation to read through, so I made a poll asking whether people on HN are looking for an exit or building a lifestyle business. If you'd like to respond to the poll, it's at:

https://news.ycombinator.com/item?id=6970735

It seems to me:

VC funding = 1% chance of being millionaire

Bootstrapping = 15% chance of being hundred-thousandaire

If you want to be a hundred-thousandaire, take the highest paying programming job in SV or on Wall Street. 100% success rate.

Also, 37Signals. They're bootstrapped and definitely outliers but DHH does well enough out of it to race Porsches and commission Pagani to make him a custom Zonda. The sticker price for a production Zonda ran between $1-2MM depending on model.

Selling your soul somewhat.

To paraphrase Too Much Coffee Man, selling your soul is unavoidable. Choose wisely.

If you want to be a hundred-thousandaire, take the highest paying programming job in SV or on Wall Street. 100% success rate.

Except that doesn't work, because your living costs go up massively, and you also spend a huge chunk of it on taxes... see the beginning of http://swombat.com/2013/7/24/embrace-desire-money for some thoughts on this.

Agreed. Pay stubs may end up with 6 digits, but your take home and utility of that pay is on par with someone who makes $50-60k in many other places.

I save between 2k and 3k every month in SF, after tax and rent and food and utilities and going out with friends and treating myself a bit more than I should. I live in Oakland (cheaper), but my pay is slightly below industry average (and my BART costs as a result are ~200$ a month, and I eat out for lunch every day - that's easily $300 or so a month). I don't think I'd be able to do that on a $60k salary, no matter where in the US.

The reality is that most engineers spend way too much money and call it "the cost of living in SF". Sorry, living in a swanky apartment in SoMa, eating out every night, pre-ordering hipster shit on kickstarter, taking Uber all the time and going to Tahoe on the weekends is not "the cost of living in SF". You can save money in SF very nicely if that's a goal of yours. If you prefer living a more hip lifestyle, that's fine- but don't say that it's "the cost of living in SF".

I don't know how easy it is to minimise taxes by being a contractor in the US but assuming you can do so, gross circa $300k/year on Wall Street, and live frugally (including apartment not in Manhattan, or even NYC), you should definitely be able to save at least $100k in a couple years. Granted you're temporarily reducing your quality of life, but arguably you're doing that with a startup anyway. The point is I think it's possible, not that I think it's something I would want to do myself.

To have a starting salary of 300k/year is very difficult. But if you are a star you can perhaps get to that after a couple of years. But it is pretty much impossible to get to that point if you do not live close to your job. There are people that make that much and more that live in the suburbs but they are usually the ones that have a lot of experience and seniority. If you are young and want to make that much money you have to be in the office all the time you have to have a flexible schedule, which means you have to live in the area.

You do not need to be in the office 24/7 to make $300K/year. You do have to deliver significant business value to your employer. Usually that is more easily accomplished by working steadily but leisurely, keeping a careful eye out for what problems really need to be solved that nobody else is working on, and then solving them quickly and efficiently.

It's definitely possible within a couple years (I've done it). Just live a very frugal life (have some roommates) and you can easily sock away several hundred thousand dollars.

In most companies, if you're a programmer you'll also be working with people who make a lot less money than you. If they're managing to survive in the area, just live like them and you can save lots of money.

It's still easily possible. If you save a mere $10k/year for 20 years and get a return on your investments that beats inflation by 5%, you'll end up with $350k in today's dollars.

Of course it works. I can and have lived in SV on a monthly budget of about $2000. That can be squeezed to $1500 in a pinch. Even in a year where I was severely underpaid, I saved $20,000. I came out of another year of voluntary mostly-unemployment down only a few thousand.

This doesn't work if you've got a family, but it's not that hard for a single person.

Don't get me wrong, you can still become a millionaire from a Bootstrapped company, the odds just aren't as high.

The title of the article should be:

- Investment decreases Expected Return [1]

More money won't increase the risk of your business failing, it will simply decrease your share of the profits if your business succeeds.

[1] http://en.wikipedia.org/wiki/Expected_return

No, because accepting VC forecloses on a class of exits: the single-digit or low-double-digit-millions ones, which are the most common kind of exit, and which would be highly lucrative if you hadn't accepted an investment. You could accept such an exit after taking VCs, but your share of the profits won't be so much "decreased" as "destroyed".

Getting to a mid-double-digits or better exit requires a different kind of execution and a different kind of luck than the lower kind, so, in fact, your risk does go up, because the bar gets set higher.

I believe we're addressing two different things here. On the one hand I'm talking about the "risk of business failure", on the other hand you're talking about the "risk of making less money".

Hence, I agree it makes sense to say that "investment increases the risk of making less money", which is almost the same thing as saying "investment decreases expected return".

Again, no, because in practice you won't even entertain those marginal exits: they will have no upside for you. They are foreclosed upon financially. Your return on investment isn't merely reduced in those cases; it is practically eliminated.

Would you care to elaborate how this relates to the "risk of business failure"? How would taking money from investors increase the risk of a startup not being able to develop a successful business model and become profitable?

The startup world is so complex and sometimes random that you can't just come up with a general rule, add "almost" and think you nailed it.

There is no general rule when it comes to investing and no "almost" is gonna change that.

Please stop thinking there are general rules to "correctly" doing a startup.

I agree with your specific point but not with the general feeling implied. I'm the first one to agree that all advice is contextual.

However, my observation there is based on the people I speak to. Many first-time founders that I speak to (in London or parts of the world other than Silicon Valley) think that funding will reduce their risk. For most, that is incorrect. Therefore, saying that in the contexts which I've observed, it's almost never good for first-time founders to raise funding seems like a fair statement, and useful to most readers in the category of first-time founders or people thinking of starting a business.

I would posit that studies of lottery winners and human psychology could help predict the behaviors and fates of founders that receive VC-funding.

Founders may have much better (self-selected) odds of success, but financial management remains a separate skill-set from product/service development and funding solicitation.

Other studies demonstrate that wealth tends to decrease empathy and influence the mind in other ways. Whatever their past history, you are dealing with a different person after they take VC funding. This goes doubly so for predicting your own behavior, given the intrinsic limits of self-awareness.

This is why I have taken a tiered approach to my own creative projects.

I started with a small Kickstarter, just enough to gauge whether people would pay for a novel. That succeeded. Even though the funding failed to cover all the production costs, the several hundred dollars in expenses after that made for a very cheap education in crowdsourcing.

For my next project, I plan to do an anthology. It requires similar skills to a novel, but involves working with many more people, more coordination, and more money. Even if I lost all of my work and had to start it from scratch, though, it would only put me out a few thousand dollars.

Only after a such few projects, each of increasing complexity, will I take on even a small-scale video game Kickstarter. By that time, though, I will have mastered all of the production skills and will only need to ramp up on each.

And the most important of those skills? I will know what to do with thousands or tens of thousands of backer dollars. That way, even a wildly successful Kickstarter (and video games are the most-funded category) will require managing perhaps only 10x more money than before, rather than 100-1000x. I will already know what I don't require to get a project out the door.

I agree completely.

"...but being first-time founders, they are already carrying enormous amounts of risk, because they don't know how to run any kind of business, let alone a mega-successful high-growth tech startup."

I think the author is right if for no other reason than this statement. Running a business is hard enough, but taking investment increases the complexity of the business side of things. And that alone increases risk.

> because they don't know how to run any kind of business, let alone a mega-successful high-growth tech startup.

(1)For "run", this is a common statement, but I believe that it is contradicted by oceans of simple observations: The US, coast to coast, village to the largest cities, is just awash in solo founder, entrepreneur, small and medium family businesses. Examples include auto repair, auto body repair, grass mowing and landscaping, plumbing, residential and small business electrical, roofing, carpentry (e.g., for a deck), swimming pool installation, dentistry, family practice medicine, restaurants of various kinds from franchised fast food to pizza carryout, Italian red sauce, French bistro, and Chinese carryout, a hardware store, a restaurant supply store, a huge range of big truck, little truck businesses where the owner buys in large quantities and sells in small quantities, independent insurance agency, medical testing lab, and many more with variety too large to characterize. E.g., in my neighborhood the shrubbery around a house was too large. So, a team came in with a simple chain saw and a few simple tools, and cut way back all the green, loaded it on a large sheet of plastic, dragged it to some woods, and piled it where it will slowly decompose into 'soil'. Apparently the team was recently from Mexico, but they had a nice, new pickup truck.

There are millions of such businesses in the US where the owner, sole proprietor makes money enough to be a good breadwinner, and the more successful such owners make money enough for a vacation house, a restored muscle car and other toys, and a 50' yacht. In my area it appears that the electricians work four day weeks, i.e., Friday is golf day.

For example, a guy good at managing 10 fast food restaurants can pay himself over $1 million a year.

Flatly, these business people definitely do know how to "run" their businesses. Even a guy recently from Mexico, China, or India can quickly learn how to "run" his business.

(2) For "mega-successful high-growth tech startup", if this is a serious problem, then there is an easy solution: Convert the business to a mega-successful low-growth tech startup. Generally conversion from low-growth to high-growth is challenging but conversion from high-growth to low-growth is easy.

A guy in business who is able to get plenty of paying customers can get a lot of advice on how to run a business from bookkeepers, accountants, lawyers, business insurance agents, bankers, friends, mentors retired from business, etc. It works, everyday, all across the US, in many millions of cases. It's putting kids through Ivy League universities, paying for family winter ski vacations and summer boating/fishing vacations, paying for high end cars from Mercedes, BMW, Cadillac, Lexus, etc., paying for single family homes at $500,000+, etc., and rarely with any formal training in how to run a business.

The general idea that how to run a business is really obscure knowledge is wacko; tell that to a guy doing well mowing grass -- three teams, each with about $100,000 in equipment -- with much less than a high school education, poor knowledge of English, and recently from Mexico without benefit of papers.

If an information technology business can get customers and revenue, then how to "run" the business is something many millions of sole proprietors learn on the job and not some secret, black art.

I agree with your general point, and I'm inexperienced in this stuff - but isn't converting from high growth to low growth going to spook VC investors? I mean, you're probably right that people can figure out how to run their business - but is that conversion reasonable with investment?

You don't really have to "convert" but from the beginning just don't let the rate of growth get out of hand. So, if you can't grow fast enough, say, can't recruit and train new employees fast enough, get more office space, etc., that is, don't want the headaches of 40 hour days from really fast growth, then have essentially a 'shortage' of what you are supplying in which case you take the usual approach of raising your 'prices'. So, at a Web site, ask users to 'register' and limit the number of new users per month. Or if you are selling something, then just raise your prices. Or if what you are selling is ads on Web pages, then try to go for better user 'demographics' and, thus, get higher 'click through rates' and, thus, higher 'cost per 1000 ads displayed' (CPM), etc.

If you have some nice traffic, then hopefully you are cash flow positive or have enough cash to make do while you hire slowly and carefully and train your new staff, improve your product or service, handle all the routine stuff such as business checking account, bookkeeper, accountant, tax record keeping, trademarks, domain name registration, business insurance, legal issues in HR, legal issues of using a residence as a business location, get a car for business use, etc. Then with all that routine stuff behind you, a good staff in place, and some cash in the bank so that you won't be late on your credit card payments, etc., then let the growth rate increase, prudently.

I contacted a lot of VCs and slowly learned what they wanted if only from what they were silent about that they didn't like. About the best feedback I got was from Menlo Ventures that said that to write a check they wanted to see, for a Web site business, 100,000 "uniques" per month. So, take that number, some reasonable usage scenario of a Web site, and a reasonable CPM and do the arithmetic on revenue per month. Will likely find that the revenue is plenty for 1-2 people and computers, bandwidth, supporting a small family, etc. That is, before they will write a check, you must already have a nice business, likely already better for you and your family than 95% of employee slots. And for such a business, you might need only one or a few servers at about $1500 each, where a guy mowing grass needs a riding mower at about 10 times that, plus a trailer and a truck, many times the capital equipment you need. Indeed, the grass mowing guy likely gets bank loans, and maybe you could do the same if you maintain good relations with a local banker.

So, you are looking much better than a grass mowing guy; e.g., to grow, he needs more bodies, but for you to grow you just need to handle the paper pushing, which is a lot less than twice the work for you for twice the revenue, etc. and otherwise grow your server farm that works and makes money 24 x 7. Do the arithmetic: A dozen servers kept busy sending Web pages with ads puts you in the 1% in a big hurry.

If your Web site traffic is high enough and growing nicely, then maybe a VC will write you a Series A check for $3 million to $30 million expecting you to rush out, rent offices, furnish them, hire lots of people, use 'real' servers in racks instead of servers in mid-tower cases you plug together from parts, have a Diesel generator for backup power, etc.

But, still, if you keep down the growth rate, then you can keep down the headaches per week and the number of weekends at the office.

A well managed business doesn't have to be a total rat race, at least not for the CEO: A secret is to divide the work into well defined pieces (as founder, you are supposed to know what such pieces are), for each piece, hire a head guy, expect each such head guy to handle his piece, check up on him once a week, that is, get his 5 minute report and ask him if he needs help from you and where, and otherwise let him do the work of his piece. If he is getting his work done and not causing any headaches for you, then enjoy counting the money in the bank.

The main business challenge is just getting in the customers/users and their revenue; the main technical challenge is getting the software written; one of the keys is just having a good business idea that you have executed well enough. Essentially all the rest is routine until time to sell out, if you wish, and even there can get a lot of expert advice.

This stuff about 'information technology' is a super nice area of business, i.e., 'clean, indoor work, no heavy lifting'. Think instead about a guy killing 5000 hogs a day, chilling down the parts want to keep, getting rid of the rest in a way that doesn't have the state EPA on your back, the next day cutting the hogs, putting the pieces into boxes, loading the boxes onto refrigerated 18 wheel trucks, and driving the trucks a few hundred miles for sale. Then Excedrin Headache #948,224,395: It's winter and one of your 18 wheel trucks loaded with 40,000 pounds of fresh pork slides on ice on a highway at a toll booth, takes out the toll booth, injures the toll taker, wrecks the truck, and spreads all 40,000 pounds of fresh pork on the highway. Don't expect an MBA program or a VC to help you clean up such a mess! But, not likely to happen with just a Web site! Instead you get to worry about SQL injection, easy enough to avoid just by checking out user input before letting SQL see it or arranging, as is routine, that SQL sees the user input only as data and not as a T-SQL command! Likely shouldn't ask the IT guys at Target just how to do this!

I think this depends on whether you're looking at funding from a business-centric or founder-centric perspective. The business-centric contention is that you should only seek funding once you have a business idea that all your analyses show would be immensely profitable except for your company's lack of money, since otherwise you're adding unnecessary risk.

Founder-centric organizations like Y Combinator (I've never been funded by Y Combinator so please correct me if I'm wrong with this assessment) seem to have different dynamics and motivations. Instead of investing in the business, they invest in the people much like a college -- realize they are going to screw up from their inexperience, but give them angel-level amounts of money, latitude to pivot, and world-class networking opportunities and help.

One consideration is how much control you give away when you take funding. If you retain control of your board, and generally take beneficial terms on the funding, it doesn't have to change the way you run a bootstrap business. Case in point: 37signals.

There are money other examples too. I know a very popular business that is successful, VC funded and will likely not have an exit because the founders retain control and they don't want to do that. There are other options (dividends, secondary markets) that can give liquidity.

I don't think creating a "startup" style business, with a scalable-repeatable business model, that is only mildly profitable is particularly common. Either you can be pretty darn profitable, acquihired (usually brokered by investors), or fail.

Daniel seems to be talking about lifestyle businesses maybe, and I agree - lifestyle businesses will be ruined by investors and decreases the odds of a big personal win far too much.

It can make sense to take the funding instead of bootstrapping, so you don't risk losing all of your own personal money. The article didn't really address that issue.

Investment decreases your risk. Before investment, you have a 50% shot at zero or negative ROI. You have a 35% chance at salary-level return. You have 14% chance of a low multimillion dollar return. You have maybe 1% odds at a very high return -- if you've got a business model this good, you'll be fighting funded businesses too.

After investment, you have 95% odds of salary-level returns. Investment lets you pay yourself a salary. Your odds of low multimillion dollar return go to vanishingly small -- maybe 1% -- unless you're really at the edge, it is either eaten by liquidity preferences, or bigger. Your odds of very high return jump up to 4%.

I agree with the authors perspective. You want to give your dream up start pitching, if you want to make it real start working.

"For example, building a business worth £20m is a pretty amazing achievement, but if you've raised £10m from a VC to get there" Building a business with little or no funding to be worth 20 million is amazing. Taking 10 million to build something worth 20 million is an abject failure and should be treated as such.

The story focuses primarily on external factors that could remove choices and control from the founders, but it feels a bit one sided, in that Daniel is externalizing the factors concerning funding.

Hence, I'd like to digress a pit from the story and draw attention to some internal (mostly psychological) reasons to take funding ... or not.

Drawing from experiences and observations from investment management and investors behavior (mostly) outside the sphere of start-ups, I can confidently say, there are polar opposite behavior that results from taking/using/managing someone else's money.

a) For a fairly large number of people; accepting someone's money brings about accountability and reduces personal recklessness. These individuals usually thrive under situations where they are held accountable and appreciate the benefits of experience, mentoring and someone believing enough to hand them their money. Sure it may reduce some choices, but the perceived value is easily offset by the growth and change is life perspectives.

Most people don't quite think this far, but they should. If first-time founders have seen themselves be more accountability when the burden of risk lay upon someone else, then by all means they should find investors who would help them down this path.

To reiterate, the key for this group of first-timers is to find the right investors/angels for their start-up, Daniel's situation would likely only play out if they were to hasty to take any money rather than the right money.

b) Then there are the inbetweeners, these are the individuals that do not find the value in giving up their choices (however limited the scope) in exchange for the perceived benefits, or lack thereof. Accepting someone else's money may also be viewed as a burden or source of stress and things not working out as intended may be viewed as failure or reason to give up.

If they recognize these traits they should be extremely careful when accepting any funding, and this is the group that would most benefit from Daniel's observations.

c) On the flip side of the first group are the individuals that are extremely callous when taking additional risks, over spending, living beyond the constraints of their current situation when someone else's takes on the burden of the risk.

I don't want to judge, but I would find it rare for these individuals to not take funding. They would mostly be the personalities that seasoned angels and investors recognize or watch out for. Perhaps VCs of the yester-years may have liked them. I personally see them as more dangerous to investors that the removal of choices are to their success.

I am sure the psychological profiles are also a good thing to know and understand when choosing co-founders, and that would be a greater concern than taking funding, but I'll leave that for another day or another topic.

There is one really strong reason to take VC funding: to eliminate all personal financial risk. See, personal financial difficulty is pure poison and if you can eliminate the risk of it entirely, then go ahead and work with a VC to do so.

If your deal with the VC is going to allow you to move seamlessly from your day job to paying yourself enough to cover your living expenses (say, $10k per month) running a not-yet-profitable business, then take it and feel no shame. Yes, the VC is now your boss, but that's OK because you have the security of a typical job.

Right now, though, the VCs only want to work with people who are already showing traction and don't need them. That's their prerogative, but that means that almost no one they want to work with should be working with them. If you don't need VC, then don't take it. It really is the capital of last resort.

What you should never do is let VCs in to your bootstrapped business where you already took personal financial risk for over a year. You've put a lot on the line, while they're taking no break from their cushy $500k++ jobs. It's only fair, given that comparison of conditions, that they should be in the outer darkness.

Agreed 100% on the value of eliminating personal financial risk.

However, I do think that it's possible to get enough traction for investment without taking on any personal financial risk. You can build an MVP over nights and weekends and start selling it enough to demonstrate market need. For good VCs, that + a compelling story should make them interested.

This is strictly my opinion.

I keep hearing from people "oh you need funding", "you need to give a way 25~50% for X amount of money", "you need to capture the market".

I just find this extremely annoying. I want to build a business, a profitable one, by not owing anyone anything. I want to be in control because I am passionate about the technology and the problem it solves.

What I can see from a macroeconomic point of view, is the previous generations grasp at innovative output by the younger generation. They are essentially declaring a "piece of the action" for something they see only as a money bet. For someone with a billion dollars, spraying six digits to several companies is not a big risk. Consider how much work that now needs to go in to satisfy their expectation-go big or go home. This is ultimately bad for the consumer choice and the economy. Much human capital and time is wasted when good services and useful product needs to get shelved because they didn't struck a homerun with the investor etc within the time frame allocated.

I don't want to be part of this mickey mouse game. I want to know what it takes to build a profitable business from nothing, because ultimately I'm not in it soley for the money, I want to actually solve problems that I think is worthy of solving, and I need to be able to do this at my pace.

Leverage from outside money is a double edge sword as all day traders know. It magnifies profit but it also magnifies loss. I see companies that just keep on getting money without ever thinking about positive net profit growth, and instead what the next idiot will think the company will make in the "near future", however long that is. I simply do not see this working and neither did Warren Buffet during the dotcom bubble, the idea that share price today is reflected on by not cash earned today but what it could make tomorrow is insanity (la nouvelle économie ooh la la)

I too support bootstrapping vs. funding, I mainly feel that the intellectual value is being exploited by profit at all cost kamikaze capitalism, and I just wonder how the attitude will change when we see the likes of Facebook and Twitter collapse in the oncoming market correction, when the next investor comes along and starts to worry that they won't be making net profit this year or the next or the next, and that it's a giant pump and dump scheme, where the victims will once again be duped investors.

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