Swing for the Fences or Focus on 1st Base?

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.

Comments

[Scott Rafer]

"Long-term shareholder value," isn't specific enough. The clarifications you make get you most of the way there, but all the way. LT Value can either be CA$H which you can invest however you wish, or public equity where you have a lot of liquid paper wealth but haven't diversified (talk to Bear, Stearns and Lehman execs about that). My bias is for cash money, clearly.

Just as critical, I'd phrase it as LT Value for *current shareholders.* You might find that to be implicit, but first timers often do not.

With super, super VC deal terms, the expected value (probability * outcome) of raising money probably comes out close to even. However, it's a handful of people that can get those terms consistently over time from institutional investors. Neither you nor I are currently anywhere near that list, never mind rookies. Once LiqPrefs, Participation or Pro Rata investment rights enter the equation, game theory analysis starts becoming required to value the Common, i.e. the Common is hosed from a risk-return perspective.

To turn the bad VC baseball metaphors back on their originators -- base hits win ballgames.

[Jordan Mitchell]

Thx for the comment, Scott. Yeah, just a general line of thinking clearly -- not specific.

I just think it's interesting to consider that:
-- huge VC financings may now be just as at risk for a low shareholder return, as smaller angel financings.
-- many who raised money on a "swing for the fences" game plan are now all about the base hit.

[Neal Richter]

I'll leave the financing question to the $$ gurus, however here are a few pertinent baseball facts:

Ted William's on base percentage is 48%, slugging percentage is 63% and 23% of the time he crossed home plate.

Hank Arron's on base percentage is 37%, slugging percentage is 56% and 17% of the time he crossed home plate.

Yet both players hit home runs on 6% of their at bats. So my take away is that being an opportunistic hitter leads to more contact with the ball (revenue) and more runs.

[Dave Hardwick]

I think your analogy is wrong, because it neglects the current economic conditions.

A better baseball example would be:
- Each season, MLB changes several conditions of play. For this season, the following conditions apply:
1) The ball is 1/2 the size of the previous season's and is black, not white.
2) The side of a diamond is now 180 feet, an increase from 90 feet that we now use.
3) The pitcher's mound is set at 45 feet from home plate.
4) Nobody is allowed to wear spikes, or other traction-improving shoes.

Now, go play ball.

Next year, we'll introduce new conditions!

Bottom line, there are a lot of great ideas out there, and now is probably not a good time for many of them. But, there are probably other ideas that are that wouldn't have been 3 years ago.

Interesting times...

[Bill Harding]

Great post! As the operator of a site that is "swinging for the fences" and "focusing on first base" (i.e., bootstrapping a market opportunity of > $100M (company=Bonanzle)), I often ask myself whether we should be looking for investment. To this point, my conclusion has been that so long as we continue to become increasingly profitable, eventually the investment community will notice us, and eventually they will make a deal that is sufficiently in our favor that it makes sense to take.

Of course, that is predicated on not having one of the missteps you allude to above, which is difficult when bootstrapping without flawless execution.

What it boils down to as I see it is that right now seems to be an almost unprecedentedly bad time to seek investment, both in terms of the deal one will get, and in terms of the amount of time it takes to find that bad deal. Since every other company faces these same challenges, I think that this is a safer environment than most to bootstrap in, since our competitors are less likely to become funded as well.

But "the window" you allude to does make me a bit edgy...