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An Inside Look at Venture Capitalists
Christopher Thomas writes: "IEEE Spectrum has a scathing review of venture capitalists this month. Authors Nick Tredennick and Brion Shimamoto paint a devastatingly cynical picture of venture capitalism from the engineers' perspective." Funny to read, but probably 100% accurate. Wow.
They're not called "vulture capitalists" for nothing. They'll squeeze you for every last bit of stock and control possible. So, before you begin talking to them prepare yourself! I would try and take my project as far along as possible before selling any shares to these people. If you want more detail on just what I'm talking about visit the bootstrapper's website which will show you how to do this. Remmember the more sales you have the stronger your negotiating position will be.
I have to disagree that Venture Capitalists will "squeeze you for everything." Unlike many in the "those that can't do--teach" category, I've actually done venture capital deals. I've also done private offerings (equity financing sold to individuals), bank financing and debentures (privately held debt) -- as well as non-traditional methods of raising cash.
At different stages of growth, different types of capitalization are appropriate. In my experience, Venture Capital is most appropriate after you've gotten a start-up off the ground and built a management team (which can be as small as two people).
Besides going for Venture Capital mid-way into your growth pattern, you need to have a business that can realistically offer very high growth. If you have a less explosive business, private offerings can work -- they can be successfully sold if the folks get 2-3 times their money back.
Other options include setting up a non-profit entity alongside your start-up, assigning a charitable or socially helpful role to it, and seeking grant monies from private foundations or corporate foundations. The grant money can help offset operating costs for your for-profit start-up by paying you a salary and covering some office expense and equipment.
Still other methods for raising capital include piggybacking with established businesses. For example, a publisher can get an endorsed promotion of a book or booklet from a large association, the association solicits orders for the book via its members' newsletter, you split the revenues with the association, and generate substantial incoming cash.
I can attest to this from personal experience: I am one of a small group of people to have received the (questionable) pleasure of being cold-called by a VC firm. It didn't matter to them that I was still finishing my BSc in mathematics; all that was important to the VC was that 1. Distributed Computing was hot, and 2. I was responsible for a recent distributed computing project.
Of course, calculating Pi isn't likely to be commercially profitable any time soon; for that matter, distributed computing isn't either. So I wrote back explaining that I had no intention of helping them waste their investor's money on ventures doomed to failure.
Ever since then I've refered to that day as "the day I refused five million dollars".
Tarsnap: Online backups for the truly paranoid
Nope, there are, in fact, different kinds of geeks. There are the clueless geeks who think that they can make a quick buck by developing big sounding technology with expensive tools and on impossible deadlines. Sometimes they get lucky, but more often, they get f*cked.
Clueful geeks never participated in this game. They work steady jobs, save money, run small consulting business, and generally are having a much better time. If a VC contacts them, they just politely refuse.
You don't need millions of dollars in order to be happy. Engineering and software development is a decent way to make a living, and you can be quite well off without ruining your health on startup dreams.
Oh, as for the open source startups, the VCs that invested in them were fools. But if VCs are going to waste their money, they might as well waste it on something that contributes to the common good. I suspect many engineers working for such companies weren't dreaming on getting rich but just liked the idea of creating open source software fulltime. (Support of open source by companies like Sun and IBM, on the other hand, makes business sense for them.)
The old saw about "The world beating a path to your door if you have a better mouse trap" is pure hokum. The one thing that Microsoft proved with Windows 95 is that if you have enough marketing money you can sell anything - no matter how bad it is. Conversely - take the best commercial program you can find - write up a sign that says "Software $5.00" stand on a street corner with the sign and see how many copies you sell. I have tried that: all you'll get is sun-burned; marketing is far more important than product when it comes to making money in a business.
To be fair, some VCs do recognize this and do something about it. I have a friend who's been involved in a few startups. Not too long ago he described what had happened in one funding round. BTW, you're practically always involved in some sort of funding-related activity or another, all day every day. If you're a true techie you'll go insane wishing you could sit down and write code again. Anyway, this is basically what the lead VC said:
What ended up happening is that some of the previous-round investors saw their share reduced so the founders' share could be increased. I'm sure they didn't like that much, but I'm also sure that if it was presented as a choice between that and losing the lead investor (with nobody else ready to step in) they would have gone along. Losing the lead investor like that at that point in time would basically have meant that the company had zero prospects of survival (in fact it did not survive).
The upshot is that a "vulture capitalist" really - for once - did try to do the right thing by the founders, and even leaned on other investors to make the right things happen. They're not evil people. They're ambitious, they're greedy, they're often ruthless, they almost always have goals that are at odds with techies' goals, but they do have honor.
I wish I could name the east-coast VC company involved, because I like to see good behavior rewarded. Unfortunately, I don't feel safe doing so. One character trait they hold very dear is "discretion"; it's not very discreet to tell stories like this one in a place like slashdot, and I might want to do business with them myself someday. ;-)
Slashdot - News for Herds. Stuff that Splatters.
A few thoughts on VCs, Engineers, and Managements:
1) VCs, in general, are not very trustworthy. They are in business, they are looking to make money, and they are not afraid to step on some toes to get it. I don't think there is anything particularly shocking about this, but it is something to keep in mind when dealing with them.
2) "Your ideas, Your work, Their company" - let's not forget their money. As the author of this article himself points out, it is very difficult to raise money. The fact that VCs give people astronomical amounts of money and ask for something in return (i.e. a share of the company and a voice in how it is run to protect their investment) is not unreasonable.
3) VCs, like most people, and especially those controlling large amounts of money, tend to have a herd mentality. Do they take more risk than the average investor? Absolutely. Looking at the number of ideas that have been funded in the last few years and then turning and blaming vcs for not funding "enough" risky ideas to me seems pretty silly.
4) Good management is critical to the success of a company. This may be anathema to many of the people who frequent this site(or at least this topic), but one of the mantra's of VCs is "management, management, management." Now, I am an engineer, I started a company, but I am more than willing to admit that:
A) I am not well suited to managing it
B) If I don't find someone who is, the company will have real difficulty succeeding.
Now, obviously there are many examples of companies that have been run into the ground by bad management. Does this mean that management is evil or (perhaps even more absurd) unnecessary? No. Good management is critical to a company's success, just as bad management is critical to its failure. This may not be pleasing to our egos as engineers, and there may be exceptions to this, but having worked with some good managers and some bad ones, it seems to me to be generally true.
5) Engineers are often not good managers. Let's be honest here. Sometimes the guy from Wharton is a really lousy manager. But just as often (I would argure more often) the brilliant programmer is also a really lousy manager. Being a good manager is an hard-to-acquire skill, in some ways as nuanced and difficult to achieve as technical proficiency. Just as a cs degree does not assure programming competence, neither does an MBA assure management competence.
6) In general, I found this article to be whiny and annoying. Yes, I don't like VCs either. Many of them are "sharks"(as I was told before I got involved with them, and have generally found to be true). They are not necessarily (and I would argure are rarely) the best businessmen, the best partners, or the best engineers. They are though the guys with the money. And if your talking to them, you are most likely the guy who needs. Now, the historical balance of power in relationships between those having money and those asking for it does not need to be summarized here, except to say that one of them (I'll give the author of the article a hint, not the one without it) holds a significantly stronger position.
What would be nice is a more practical-minded article about engineers dealing with VCs(because there are many useful things to keep in mind, and are things to watch out for, even if you don't have an axe to grind), rather than the sort of flailing complaints that we have received here.
John
Now, I'm sure that in the Real World it's more often that the IP would be worth $150 million, and the engineers brought in maybe $5 million, and the VCs only pitched in $50 million, and the engineers end up with a 15% share of something they conributed 75% of.
It takes money to make money. You might have a great idea, but generally great ideas need financing. I might make the world's greatest cheesecake, but without the hundreds of thousands of dollars needed to buy a restaraunt, outfit it properly, fill the pantries and larders, hire and train employees, purchase advertising, invite the media &c. my idea is worth very little indeed. Someone needs to finance me--and he's taking a huge risk. That costs me.
The best solution is to finance your activities yourself. If you cannot, sell the rights to your IP to others. You lose the opportunity to become the leader and known name in that market (which one needs to survive after the patents expire), but you turn your idea into cash. You might then use this cash to fund another idea, and this manner become the market leader. When the patent expires, it doesn't matter, because everyone knows and trusts the Smith family of widgets. And then you'll have a profitable corporation.
Remember, though, that it's more lucrative to have a 1% share of a $100 million concern than it is a 10% of a $5 million concern.