Who is more likely to produce long-term shareholder value -- the entrepreneur who raises too much investment capital, or the entrepreneur who funds growth through profits alone?
First time entrepreneurs often have skewed visions of "how it all works". Their perceptions are often shaped by the numerous successes that get touted about the media, rather than by the 1000-fold number of failures. It makes the "accidental success" of YouTube appear reachable, or at least "just as likely" as any other startup.
One of the things that entrepreneurs usually believe is that once they have an idea, they need investment -- that's just how it works, right? Once they start to talk to investors though, as well as advisors and other folks in the startup community, the questions usually come up ... is this a lifestyle business or a "swing for the fences" big market opportunity? A "lifestyle business" is one which you intend to keep running for a decade or two -- like my Dad's optometry practice, for instance, or my brother's event audio/visual recording business -- typically an owner-managed business in which the profits are used solely to support the ongoing lifestyle of the proprietor.
Then there are the "swing for the fences" big market opportunities. These are the startups with big goals, where the entrepreneurs focus on a market opportunity >$100M. To get there, most companies on this track sell ownership in their company at some stage of their business to raise the capital necessary to build their company. Some companies even raise huge amounts of venture capital, at a hefty dilution mind you, before they even arguably HAVE a business. (Twitter comes to mind ...) Investors are compelled by visions of a healthy return on their investment, and in the latter case also by extremely savvy entrepreneurs.
For whatever reason, I'm NOT a "lifestyle business" kinda guy. I'm only interested in building a company with a compelling market value and resulting shareholder ROI, but as a founder I'm ALSO uninterested in immediate dilution down to single digit % ownership. I want as much equity in the company as possible.
I learned long ago that the best way to build personal wealth and shareholder value is through "bootstrapping". Bootstrapping is the art of building companies with very little outside capital/investment. I'm proud of my bootstrapping skills actually, which I've developed over four startups now, yet I've also realized that outside capital is also essential to developing/realizing a substantial market opportunity.
The reality is that there is a middle ground. Bootstrapping your way 100% to IPO, while honorable, is very difficult and uncommon. If the market opportunity is truly there, being under-capitalized will usually result in missing the market window of opportunity. Conversely, raising too much capital too early rarely results in long-term shareholder value. In other words, given a large market opportunity -- a startup that raises too much investment capital is just as likely to fail (to generate shareholder value) as a startup that doesn't take any investment capital.
I've been building Others Online based on what I thought to be an appropriate balance of equity financing and bootstrapping ("sweat equity" financing). Unfortunately we're still not profitable and thus reliant on investment capital at a time when the market opportunity is large and we're landing large customers, but market conditions are unstable and investment capital has dried up. And the other day I was talking to one of my investors, who literally wrote the book on bootstrapping, about our status as a company. He insisted that there "has to be a way" to generate more cash from our pipeline immediately. The only way I can see to do that is to shift our business model in the short-term, and I worry that doing so may negatively impact our ability to achieve the "big market opportunity".
I keep thinking about this. Is it possible to "swing for the fences" (big market opportunity) at the same time as focusing on 1st base (getting to cash flow breakeven)? Or are the two incompatible? I suppose it depends on the market opportunity, but I'd argue most high-value windows of opportunity in the market are open for a limited period of time. Rarely do you not have competition eyeballing the same opportunity, and sufficient funding is generally a prerequisite to nailing these windows of opportunity.
Market leadership positions are always attained as a result of execution. Financing is not execution. However, financing provides the means to develop the necessary components to execution: team, timing, marketing, and product development. Since paths to success are rarely a straight line, financing also helps recovery from bad decisions (on any of the above). Under-capitalized companies are therefore at greater risk. That said, bootstrapping is also essential. It teaches you to make your mistakes quickly and therefore least costly. Bootstrapping is good execution.
2009 is going to be a difficult time for companies who are "swinging for the fences" but aren't financed for the next 12-18 months. If you're one of them, like we are, it seems you can only either change your game plan and just focus on 1st base, or merge your team with a team in a far better position to hit the home run.