Chapter 5 - Bootstrap or VC?
To read:
Why launch a startup: For the big money and for the opportunity to control your own company, certainly. But new research from Harvard Business School’s Noam Wasserman shows that those goals are largely incompatible.
Startup upstart: As VCs from both coasts join the move to Austin, Texas, the city is the new land of unicorns and tech giants, writes TechCrunch magazine.
Pitchbook: PitchBook tracks every aspect of the public and private equity markets, including venture capital, private equity, and M&A.
The gems of GEM: This UK-US consortium paints a picture of the planetary level of entrepreneurial activity, examining entrepreneurial motivations, intentions, and attitudes around the world.
The VC Lab: The VC Lab program helps innovative fund managers launch impactful venture capital firms in 12 months or less, says founder Adeo Ressi.
‘For the good of humankind’: As a public benefit corporation, data.world seeks to maximize data’s societal problem-solving utility
The VC as ‘Sherpa’: The partnerships between entrepreneurs and VCs are akin to the relationship between the Sherpas and climbers who scale the heights of Mt. Everest.
Chapter 5
Bootstrap or VC?
Two roads diverged in a yellow wood,
And sorry I could not travel both
And be one traveler, long I stood
And looked down one as far as I could
To where it bent in the undergrowth;Then took the other, as just as fair,
And having perhaps the better claim,
Because it was grassy and wanted wear;
Though as for that the passing there
Had worn them really about the same,And both that morning equally lay
In leaves no step had trodden black.
Oh, I kept the first for another day!
Yet knowing how way leads on to way,
I doubted if I should ever come back.I shall be telling this with a sigh
Somewhere ages and ages hence:
Two roads diverged in a wood, and I—
I took the one less traveled by,
And that has made all the difference.— Robert Frost, “The Road Less Traveled”
Any conversation on the virtues of bootstrapping your way to success as an entrepreneur versus growing to scale with the investment of venture capital dollars usually boils down to one question: “Do you want to be rich, or do you want to be king?”, as business scholar Noam Wasserman once framed it so well.
It’s a very good question. It’s also the frame for the central paradox of entrepreneurial decision-making.
It’s a paradox because in my experience of mentoring entrepreneurs at the start of their journey, the answer is usually, “Well, both!” At which point, I’m always tempted to invoke another paradox, that of “Buridan’s mule,” posed by the 14th-century philosopher Jean Buridan. In his hypothetical paradox, Buridan imagined a hungry mule placed at an equal distance between an appealing stack of oats and an equally desirable stack of hay.
You’ve probably heard a version of the story and already beat me to the punch line: Buridan’s indecisive mule starved to death trying to make up his mind. This, I’m sad to say, is the fate of many a would-be entrepreneur who have not decisively come down on one side of the question or the other.
Not that it’s impossible for an entrepreneur to have both their oats and hay. Mark Zuckerberg did. Elon Musk enjoys the two. Peter Thiel and Jeff Bezos are further examples of the extraordinarily rich who are also “kings” of their realm... but they are also major outliers. Their storied success should not distort your vision. One example of the role of fate’s capricious hand is Zuckerberg’s 2006 rejection of a $1 billion offer from Yahoo's then-CEO Terry Semel. There are several versions of the story, but the prevailing one is that Semel’s team wanted him to return to the bargaining table with a sweetened offer of $1.1 billion. But Semel, in a fit of pique, refused. Later, it was revealed that Facebook’s investors and board were prepared to force Zuckerberg to sell if Semel had returned with that price. How different history might have been if that’d happened? Semel resigned from Yahoo! a year later and now serves on the board of the Los Angeles County Museum of Art. Facebook’s valuation, meanwhile, hit $1 trillion in May of 2021, and Zuckerberg retains full control of his company.
I’m dwelling on this because I want you to keep in mind that in the constellation of entrepreneurs, the odds of superstardom as defined by these tech titans are akin to those in Hollywood where 20,000 aspiring actors arrive each year, with only two or three making the proverbial breakthrough. In fact, at any given moment there are only perhaps 10 to 15 “A-list” actors living the dream of Tinseltown; if you think about it, you can probably name them. The rest are waiting on the proverbial tables or selling the proverbial cars. To build on this analogy, the dichotomy in the VC realm breaks down into two empirical views to think about it as an entrepreneur.
Before I get to those two things, I have to flag some resources here. Because the data and research on this numerically-friendly topic can be overwhelming. Those of you with scuba gear handy, however, will find three portals ready for you to dive deep off of the Digital Companion. One is Pitchbook, the most user-friendly source for commercial and financial data in the United States. A full subscription with three seats will set you back $25,000. But there’s a great deal for free at the site. Second is the Global Entrepreneur Monitor, (GEM) which is an academic consortium run since 1999 by Babson College in Wellesley College in Massachusetts and the London Business School. If your geek bonafides include a passion for math, you’ll swim in their reports. Three is the training portal, known as VC Lab, that’s focused on ethical and transparent investing. It’s a cool project created by Founder Institute’s Adeo Ressi. So back to the two views of the proper arc of startup life and I’ll boil the basic math down.
In the first view, the grand narrative is from above, the venture-backed economy is the source of dynamism in America and the global economy. In 2021, American venture capitalists, or VCs, almost doubled their investment over the prior year, according to Pitchbook. The headline-grabbing numbers reveal that venture-backed companies raised $329.9 billion in 2021, nearly double the previous record of $166.6 billion raised in 2020. A gem from GEM, among countless more penetrating insights, is the finding that optimism is bounding back globally after the first difficult year of the pandemic. Many new starters see new business opportunities improving as a result of the waning pandemic, according to GEM. Supporting this view, the entrepreneurial economy was set to soar in 2022 concludes the annual report of Intuit. Its latest New Business Insights report predicted 17 million new small businesses will be formed in 2022, a third consecutive record year for entrepreneurship.
One chief exponent of this view that times are better than ever for the VC ecosystem is the brilliant Sebastian Mallaby, author of the marvelous new book The Power Law — Venture Capital and the Making of the New Future. Venture capital is fast becoming “an enduring pillar of national power” in America, argues Mallaby in the riveting 2022 book, and I share his enthusiasm. At data.world, for example, we finished 2021 with $82.3 million of funding and began 2022 with our largest fundraising to date in Goldman Sachs leading our $50 million growth round.
The second view, the parable of caution that is backed by a different dataset, is that behind those alluring numbers are some Hollywood-like figures that bear attention — particularly if you are pining for oats and hay. In the work the GEM research consortium produced in 2021, a key finding was that 137,000 startups are launched worldwide every day. It’s an impressive number, but sobering when you consider that about 120,000 are shut down every day. In the smaller universe of true startups in the United States, not just a spinoff or a new business license, the estimate is that 250,000 are created annually.
And of those, just 4,000 will be technology startups, the sector where most — but by no means all — VC activity takes place, reports TechCrunch. The five-year survival rate for all new businesses in the U.S. is just 20 percent; for tech startups, it is half that. So, each year 20,000 would-be stars arrive in Hollywood; the output is three megastars. Each year 4,000 would-be Tech Titans launch themselves into the national venture ecosystem. You do the co-relational math.
But that’s where my analogy with Hollywood ends.
The good news is that despite the daunting odds, your options are far richer, and the entrepreneur’s prospects are hardly a gamble on rock stardom versus presentation of the evening specials. But to truly understand your odds and options, you must look into your soul and answer this question — rich or king? — honestly, forthrightly, and most importantly, early.
While theories, opinions, academic papers, and books abound on the reasons for these dynamics of success or failure, my own view is that the most important factor of all is the founders who do not confront this fundamental question. I’m not alone in this perspective.
“Four out of five entrepreneurs, my research shows, are forced to step down from the CEO’s post. Most are shocked when investors insist that they relinquish control, and they’re pushed out of office in ways they don’t like and well before they want to abdicate,” wrote Wasserman in his seminal essay, The Founders’ Dilemma, which is linked in a package of his work on the Digital Companion. “In fact, how founders tackle their first leadership transition often makes or breaks young enterprises.”
Since I’ve already brought up Hollywood, I’ll expand on Wasserman’s insight, and liken this actual reality to the famous “red pill” in the 1999 film, The Matrix. If you recall the scene, the rebel leader, Morpheus, offers the main character, Neo, the choice of a red pill or a blue pill. The blue bill represents comfort, without want, and without fear. In short, a comfortable if machine-generated dream world where all can stay in their artificial reality, the only one they’ve ever known, generated by the Matrix. The red pill, on the other hand, offers entry into the “truth of reality.” As Morpheus describes it: "You take the blue pill...the story ends, you wake up in your bed and believe whatever you want to believe. You take the red pill...you stay in Wonderland, and I show you how deep the rabbit hole goes."
I’m coming to the choice of the pill. But first, a quick review of the decision points that you’re probably familiar with. The “classic” journey begins with a bootstrap. The entrepreneur launches in their garage on the back of savings, a credit card, or a gift from parents, other family members, or friends. You’re “king” with 100 percent ownership of your business. If you want to take off that day, there is no one watching over you. You are 100 percent empowered to do whatever you want with your life and business. Perhaps there’s an angel investor involved, or there’s a group of investors in a so-called “seed round,” in which case you’re out a 5-20 percent share depending on terms and valuations. With that help, you can build out your initial team and maybe get your product moving into the marketplace, depending on how complex it will be to build and market. And you’re still very much in charge. A year or so later, you realize you can’t expand without more capital. Enter the first VC and the “Series Seed” or “Series A” round, depending on how far along you are. Many entrepreneurs can hang on to 50 percent or more through this round, particularly if there’s the beginning of a track record as defined by annually recurring revenue, or ARR, and happy, highly referenced customers. Maybe.
But the heat is on in many ways, and you’re expected to grow faster than ever before. And, with a bit of luck, let’s say you do. Soon you’ve got a valuation of $10 million or more, and you could even be profitable, even if still modestly so if you really wanted to. But you’re ready to take your baby to the next level. Enter the negotiation called “Series B,” and, by conventional logic, this is where we move our prototypical entrepreneur on to the stage where they must confront the “founder’s dilemma” and ponder surrender of the crown, and fealty to a new demanding board of directors with clout. You may still get to drive a Tesla. In fact, odds are you will if you keep on growing fast from stage to stage. But you’re about to trade it for your throne. Because sooner rather than later, your investors will be demanding the proverbial “exit” via IPO, merger, or acquisition with, in VC-speak, a 10X or higher ROI on their investment. And you’re driving the even better, more expensive Tesla (how about the Plaid) on to your next gig. With the company you birthed and nurtured fading in your rearview mirror. Agonizing.
That’s the decision tree you face. Right? Wrong! Stop. Cut. Roll back the tape to the safe house where Trinity took Neo to meet Morpheus.
In fact, you made the decision back far closer to that early scene in my anecdote. You chose the red pill when you took that first outside investment. You just weren’t really aware you were doing so. And the purpose of this chapter is really to implore you to nurture that awareness of what the question in the title, Bootstrap or VC? is all about. Said differently, you need to make that choice between Buridan’s oats and hay at the outset of your journey. And there are plenty of good reasons to choose one color pill over the other.
Let me make this personal. My father was a great husband, father, grandfather, brother, inventor, entrepreneur, patent-holder, and natural-born comedian. He had a huge influence on my life, especially on my drive as an entrepreneur. And he chose to be king, over being rich.
My father was an entrepreneur in Austin, where I was born and live now after long stints on both coasts. He blended his passion with his business. He loved to go fishing off the Texas coast, mainly around Port O’Connor on the Gulf of Mexico, and he would spend two or three days almost every week doing that. But he wouldn't just fish — he would innovate. He developed the world's first halogen fishing light. Fish are like insects in that they are attracted to the light. He patented this invention and shipped the product all over the world. Dad became successful as a result. Among some of his other innovations:
• The first synthetic food for monarch butterfly breeding. This earned him accolades in a worldwide monarch fan club.
• The largest hand-made, hand-ground telescope. The mirror has to be accurate to one-millionth of an inch. Dad hand-ground the mirror for eight hours per day, using lasers to measure precision, for more than a year. It was tremendously better than any telescope that most people could afford to buy.
• A fiberglass, street-legal race car. At over 500 horsepower and weighing 2,000 pounds with an almost perfect 50/50 distribution of weight between the front and rear axles — an innovation first pioneered by BMW — that made dad’s car a breathtaking driving experience.
• The first robotic fishing boat. This was an ongoing project when he passed in his sleep from a heart attack, and he had been working on it for over three years. You controlled it using a color digital interface from the shoreline. Because of its silence, this helped him catch the older fish, those smart enough to avoid the sound of a motorboat. As a result, Dad caught fish that he would weigh and record so that they would go down in the Texas record books. But then he would unhook them and return them to the lake, letting them continue to live. He wasn't looking for glory.
I could of course go on about my father’s innovation: his hand-made aquariums, huge kites, remote-controlled miniature race cars, koi ponds, and so much more. But the point here is that he was someone who chose my metaphorical blue pill — though his outcome was hardly a machine-generated reality. But it was predictable. He knew what he valued in life, which he lived as a king, even if he never got rich. When I was 10, Walmart approached my father, asking to carry his products in all of their stores nationwide. Dad turned them down. I remember intensely pushing my father to do the deal. Dad declined. He did not want to ramp up his operation to that level. Potentially, it would have made him extremely wealthy. It also would have complicated his life. And he knew he was happy already. I remember him looking me in the eye and saying, "Son, one day you may realize the value of keeping life simple… or you may not."
Of course, I do realize the value of the choices he made. And one could not find a more exemplary and honorable entrepreneur’s journey, designed within the context of the life that he chose to live. There’s nothing wrong with this choice, to become and remain what I’ve called a “stage one” entrepreneur. This is the route of many small retailers, consultants, service providers, and all manner of sole proprietorships. What binds them all, however, is an iron law of growth. Stage one entrepreneurs, by definition, fund growth and expansion from ongoing profits. Consequently, by definition, stage one entrepreneurs can never move faster than emerging competitors to dominate a sector, swing for the proverbial fences, or dent the universe with cutting-edge innovation. If you believe small is beautiful, take the blue pill.
My choice has been vastly different from that of my father. I took the red pill. I use that vivid metaphor because it expresses the one-way nature of the decision. I’ve made this case many times before, over coffee with students, in lectures to university and trade groups, and fairly recently before Bootstrap Austin, an organization founded by my good friend Bijoy Goswami, a philosopher of entrepreneurship who has brought together and inspired so many leaders throughout Austin. It was through Bijoy’s organization that I met so many future colleagues, including Eric Simone and Josh Baer, who became early investors in Bazaarvoice. Not only is the red pill choice one-way, a true crossing of the Rubicon, it usually leads to a finite journey that means no matter how much you love and cherish the firm to which you give birth, you’re ultimately just a surrogate parent to your “baby.” It’s a deeply personal choice and I dwell on it so because all too often it’s made casually, even inadvertently.
In my case, it was not until my fourth business, founded while I was still at Wharton as discussed in Chapter 1, The Soul of the Entrepreneur, that I took the red pill. This was when I created Coremetrics in 1999, initially funded with $2 million in angel backing. Once I made that decision, I realized I would likely never be king like my father but I’ve certainly gained financial freedom and the different kind of joy that comes from being at the center of the business-wrought innovation that is changing the world.
• With Coremetrics, I was able to raise $64 million, navigate the dom.com bust of 2001, become the No. 1 ranked web analytics firm according to Forrester Research, and ultimately exit with an almost $300 million sale to IBM in 2007.
• With Bazaarvoice, we built a company from inception to IPO on around $12 million of capital use (out of the $24 million we raised) in seven years, creating over a thousand jobs and impacting clients all over the world. We really started the global social commerce movement and changed the face of commerce forever.
• The Bazaarvoice experience also illustrates other tools at your disposal once you’ve taken the red pill, including selling equity in smaller tranches before the IPO stage. I did so on four occasions at Bazaarvoice. Enlightened investors understand and appreciate that this is in their interest and it can strengthen your hand in the market when you reach that IPO moment. In fact, doing so enabled me in 2008 to turn down a $250 million bid from a brand name tech titan and then exit with a $1 billion IPO four years later.
• And now with data.world, I’m on my most ambitious and exciting journey yet, having raised over $132.3 million to date to build the world’s most meaningful, collaborative, and abundant data resource in the world. So far we’ve created around 110 jobs but we are just getting started and having a big impact all over the world. We are a proud Certified B Corporation, and public benefit corporation, and every commercial customer we win allows us to live our global mission of providing the most meaningful, collaborative, and abundant data resource in the world - for free if you are working in the open and benefiting humanity in the process. You can reach our annual public benefit corporation report on the Digital Companion.
For me, this is truly the “arena” about which I wrote in the very first chapter. In this arena, it almost always requires capital to build a complex, difficult-to-copy solution. It isn’t the early days of technology and venture capital anymore.
The story of venture capital really begins with Georges Doriot, who immigrated to the United States in 1920 and whose many achievements included becoming a professor and assistant dean at the Harvard Business School. In 1957, he put a new ball into play in the capitalist game, inventing the VC model with what is now regarded as the first VC vehicle: his company American Research & Development, or ARD. Through ARD, Doriot invested $70,000 (for a 70 percent stake) that enabled the launch of mini-computer maker Digital Equipment Corp (DEC). Some 11 years later he was to net around a 571,400 percent return on that $70K, earning as much as $400 million from DEC’s IPO. I also must mention that Doriot backed the launch here in Texas of future President George H.W. Bush’s first company, Zapata Offshore, a maker of oil rigs.
But in the broader sense, VCs didn’t meaningfully exist prior to the 1970s, and throughout the 1970s and 1980s, it was almost all corporate VC money — by definition largely focused on strategic investment as the first priority and financial return as the second. Now VC capital — by contrast seeking financial return as the first priority — is available in the tens of billions. And if you have a business that is going to be of any significant size, you will almost always need to raise money at some point. If you don’t, someone else who is more aggressive will likely launch into your industry with massive amounts of capital and almost always overtake you. You will be left with a niche business, which may be your goal — there is certainly nothing wrong with that. You may be king in your own castle, but you won’t be #1 in your realm.
In my view, the hat trick as an entrepreneur is to swing for the fences by launching a huge business idea, get it profitable early, and then get funding to accelerate your growth (if needed, which it almost always will be). Dell (Michael), Facebook (Zuckerberg), Microsoft (Gates and Allen), and a rare few others are examples of this. I personally failed to do that with Coremetrics and I paid dearly for it with dilution, complicated even more with the timing of the dot-com crash. But I don’t look at VCs or angel investors as evil — and of course, I now am one at Hurt Family Investments, alongside my wife Debra, having invested in 124 startups directly and 40 VC funds, which allow us to have multiples of that in indirect investments. I’ll cover my lessons learned on investing in the Helping section of this book.
VCs are the capital enablers for big business ideas. And if your interests are aligned with them, you can both make a ton of money. It is prevalent all over the Valley. Most of the entrepreneurs driving the nice Teslas grew their businesses fast with VC capital, got them public, and sold a vast amount of stock (as I mentioned often even before they went public). As a model, this has taken time to really become broadly accepted here in Austin and in other places outside the Valley. I used to frequently lament Austin’s aversion to VCs, and argue that our city’s entrepreneurial ecosystem would be better off, economically, with more people swinging for the fences in ways you can only do with help. There’s growing evidence this is occurring, and in fact as of mid-2021, the Austin region was No. 9 nationally and No. 21 internationally, ahead of both Tokyo and Toronto, as the destination for VC investment. More recently, startup funding flowed in Austin last year, delivering 387 deals valued at a record-setting $4.9 billion — or 211% growth compared to the previous year — per data from PitchBook.
One good way to think about this was posed by my friend, VC Neeraj Agrawal of Boston-based Battery Ventures, a firm with a $9 billion portfolio and an early investor in and Board Member of Bazaarvoice. He has described the partnerships between entrepreneurs and VCs as less a “venture” than an “adventure,” akin to the relationship between the Sherpas and climbers who scale the heights of Mt. Everest.
“... perhaps my role as a VC is that of an adventure travel guide,’’ Agrawal wrote in an essay linked on the Digital Companion, “someone who’s climbed the mountain many times before, who knows both the terrain and the phases of the climb intimately, and can serve as a guide for others brave enough to take up the challenge.”
I can’t think of a better way to describe the VC/entrepreneur partnership than that. This is how the world is being remade and I believe the solutions to so many of the world’s problems will emerge from this still-emerging ecosystem of capitalism for the 21st century. Consider the remarkable example of the German startup BioNTech, founded with venture backing only in 2008. That young David partnered with the 172-year-old Goliath of Pfizer at the outset of the pandemic and this David-Goliath team created in less than a year the first, and by far most widely deployed, COVID-19 vaccine that has certainly saved millions of lives.
At the end of the day, you have to balance what is best for you personally with what is best for the business. Depending on how competitive and capital intensive your market is, the best thing you can do is be open to all options to fuel growth. Whether to take the blue or red pill, again, all depends on your personal ambition. I hope I’ve convinced you here that between this stark choice of “rich vs. king” the role of the VC-backed CEO is more nuanced, and might be characterized as a “viceroy.” A viceroy may not be king, but they are still a ruling sovereign with vast responsibilities and a lot of authority. To frown on others that raise money and think they are idiots for doing so is a religious argument, not a rational business argument. And the world needs rational, focused, and innovative business pioneers as never before.
So back again to the metaphor of that film, The Matrix, with this exchange:
TRINITY: (to NEO) No one has ever done anything like this.
NEO: That’s why it’s going to work.