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Archive for the ‘venture capital’ tag

What we don’t know

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[T]here are known knowns; there are things we know we know.
We also know there are known unknowns;
that is to say we know there are some things we do not know.
But there are also unknown unknowns – the ones we don’t know we don’t know.
                                                                                         – Donald Rumsfeld

I first heard the word “de-risked” from a Silicon Valley VC as he passed on the GoCrossCampus deal a few years ago. I’ve heard it a number of times since, always in the same early-stage investment context. It’s an odd word. It has always reminded me of the Rumsfeld quote, at once mixing political doublespeak with a certain higher-level truth and meaning.

And in a way, Rumsfeld and the venture capitalists are saying the same thing, although I think Rumsfeld said it more meaningfully. At the simplest level, de-risking has two components:

–     Converting the unknown to the known
–     Converting unknown unknowns to known unknowns

That is, de-risking is about taking the unknowns of a business and turning them into knowns. But it’s also about discovering what we don’t know; it’s about cataloguing the unknowns and scheduling them for future exploration.

I think this has some significant implications for the entrepreneur. I’ve found that much of the work an entrepreneur should do prior to seed funding is not simply “proving things out” but rather exploring the key unknowns that stand in the way between the entrepreneur and massive success. Said another way, I see entrepreneurs doing too much work discovering and not enough work figuring out what they should be discovering.

Doing this will enable a healthy incrementalism and structure, bringing the spirit of a scientific experiment to an otherwise qualitative exercise in guesswork. As unknowns are converted to knowns in a deliberate fashion, the business is “de-risked” and the door is opened to more significant relationships with partners and investors. Without this discipline, the entrepreneur risks wasting time exploring things that aren’t all that meaningful – or worse, will lead to the wrong conclusion about where the business should go.

And from a purely practical perspective, an entrepreneur may be surprised at how well a list of the unknowns in their business – framed as a robust list of the things that must be proven out with the money they are raising – will go over with any investor.

Written by Brad Hargreaves

August 28th, 2011 at 8:54 am

Heisenberg Raises Money

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The principle of quantum uncertainty, published by Werner Heisenberg in 1927, approximately states:

Certain pairs of physical properties of a particle — such as present position and momentum — cannot be simultaneously measured beyond a certain arbitrarily high precision.

Stated another way, simply measuring the system will cause a change in its state, making precise knowledge of both position and momentum impossible. That theme — that a system can be changed merely by observation –is common in quantum mechanics (see Schrödinger’s cat) and is one of the most challenging concepts for non-practitioners.

But I think the concept is more broadly relevant, which is why I’m bringing it up here. As my fellow General Assembly partner Jake Schwartz noted, the uncertainty principle can be applied to raising money for your startup. He doesn’t blog, so I’m taking the liberty of explaining on his behalf.

In much of economics, there’s an assumption of perfect information — in this context, that entrepreneurs know the market interest and valuation of their companies, or can at least discover it with minimal transaction cost. But economic principles rarely translate perfectly to the real world. In reality, it is impossible to discover the interest in and valuation of your company without changing it.

This is often referred to as a part of the social proof you need to raise capital. According to that point of view, early stage financings are driven less by the fundamentals of companies and more by investors’ pscyhology. The positive filter of social proof has been reasonably well-discussed: specifically, how “in demand” the deal appears to be and which other investors are participating. But the negative filter of social proof –that is, the risk that a deal seems to have been “shopped” or been on the market for too long – can be far more insidious and powerful.

This is where the Uncertainty Principle of Capital comes in. Since early stage valuations are so dependent on social proof, the mere act of discovering the “market” interest and valuation of your company will inevitably change it. Or more formally, in the early stages of fundraising, the accuracy of a valuation and the momentum of a deal cannot be simultaneously known beyond an arbitrarily high number. A quick attempt to get a “market” valuation on an early-stage company can send the interest level in a deal spiraling downwards as it gives the company the feel of being “shopped” and alienates potential sources of capital.

Much of the game entrepreneurs play when talking to investors is about minimizing the effects of the Uncertainty Principle of Capital. This can explain the adage

“If you ask for money, you’ll get advice. If you ask for advice, you’ll get money.”

This doesn’t mean “be sneaky”. But it does mean that, as an entrepreneur, you’ll need to be able to deal with no small amount of uncertainty — and will need a compensating amount of patience. For veteran entrepreneurs, this shouldn’t be a surprise. For those of you just launching entrepreneurial career, get used to the queasy feeling of uncertainty now, as it surely won’t be the last you’ll see.

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June 23rd, 2011 at 5:34 am

The Long Game

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I was having drinks with a few entrepreneurs last week, and the topic of business plan competitions came up. I ran Yale’s competition for a year while I was a student there — a sobering experience. Ostensibly, the winners of the contest were the best potential entrepreneurs. In reality, the top awards were often swept by Yale MBA candidates who spent the entire year perfecting a 30-40 page business plan with little intention of starting a real business. They’d take the award money alongside their McKinsey or Goldman signing bonus.

Most experienced entrepreneurs — or at least most of us around the table that night — agree that business plan competitions suck. But is there a way to improve them? One CEO in attendance suggested that business plan competitions be revised to focus on the real tools of a VC pitch — that is, a slide deck and in-person presentation. It’s certainly a better basis than a business plan, but I don’t think it solves the problem. Rather, it still perpetuates a false and harmful archetype of how venture money is raised.

In reality, raising capital is a long game — a process to be measured across years and companies, not weeks and pitches. The people who “win” the real venture capital game are those entrepreneurs who spend years — if not decades — building their reputation and their relationships with investors. This doesn’t mean that first-time entrepreneurs can’t raise money, but that they’re far better off spending their time setting metrics-driven goals and hitting those goals in order to build trust in the investor community than writing a business plan or shopping a deck.

Business plan competitions can’t build a comparable experience, so they’ve created a generation of first-time entrepreneurs who falsely believe that money is raised in front of a Powerpoint rather than series of coffees and beers.

If you made me redesign the business plan competition, I’d do something pretty nontraditional: a unit economics competition. The contest would be in-person and just takes five minutes per contestant: explain your business concept in 1-2 minutes and walk through one Excel worksheet presenting the unit economics in the next 2-3 minutes. No long-form writing or slides, just the basic math that explains the core cost and revenue drivers and assumptions of your company. And no 3-5 year projections, either. While it might be beneficial for entrepreneurs to fully think through their company by spending 150 hours writing a business plan, modeling out your unit economics will provide 90% of the value at a fraction of the time.

Furthermore, the winners of a unit economics contest would be more likely to build successful companies. Unlike a business plan, with a 3-5 year projection at its core, a unit economic model tends to focus the entrepreneur on the near-term opportunities with the highest likelihood of success: the kind of things that will create grounded and focused businesses rather than speculative, multi-threaded companies. And if you’re a broke student hoping to start a business straight out of a university-sponsored competition, which would you rather have?

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February 12th, 2011 at 3:19 pm


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There’s a common misconception about why people become entrepreneurs. In my chats with founders, I’ve seen that the most common driver — ahead of earning fantastic returns, working flexible hours or learning new things — is simply getting away from a bad boss, or bosses at all.

To those on the outside looking in, the world of startups looks like a boss-free paradise. After all, you can name yourself the CEO, or at the very least have control of a menagerie of roles in your business. Unfortunately, it’s usually not. That’s because someone — perhaps an investor, a customer or a partner — is almost always playing the boss role.

Truly bossless businesses are tough to find; they have to follow a few major constraints. First, they need to hit cash flow positive almost immediately. Without that, you’ll either need to keep your day job (and your boss) or take investment (and investors, which are a different kind of boss). With cash flow, you’re only responsible to yourself and your business. Second, they need to have tons of customers, even at an early stage. That way, each customer isn’t important enough to justify appeasing them. Ideally, each customer is spending such a small amount that their process of dealing with you is automated (in B2B) or your business supports high churn (in B2C). Finally, executing the concept shouldn’t require more than perhaps one or two trusted partners.

There are a few broad categories of businesses that meet these constraints, and I’m fascinated by each of them:

Affiliate Marketing / Lead Gen: This is probably the easiest vertical to get into, as it doesn’t necessarily require any technical skills. Anyone with some marketing smarts and a WordPress install can start generating affiliate revenue, and it doesn’t really come with any obligation to anyone — affiliate program managers are often at least one level removed from the publisher (you), and it’s trivially easy to switch from one affiliate program to another.

One of the beautiful things about many affiliate businesses is that the entrepreneur is also building long-term value — typically, in a targeted email list or site that ranks high in search engines on certain keywords. In that way, affiliate and lead gen businesses are also fundamentally different from (say) consulting, in which it’s tough to argue that the consultant is building long-term value in their business.

Arbitrage: An extremely broad category, “Arb” is big umbrella that could include online advertising arbitrage, proprietary equity trading or perhaps even certain types of e-commerce. But it’s probably the most common of all bossless trades, with a huge number of independent prop traders making essentially bossless livelihoods. The downside of any arbitrage-based business, of course, is that the opportunity can (and will) disappear — of all the businesses discussed here, arbs are building the least long-term value in their enterprise.

Software Sales: To fit the criteria listed above, software business require some engineering skills. But if you’re a hacker, there are few better bossless businesses. This is especially true on the B2C side, with gaming as a prime example.

Note that in some of these businesses — especially B2B software sales — there’s a fine line that prevents customers from becoming bosses, and many entrepreneurs accidentally cross over that line by doing custom work, failing to automate sales processes or relying too much on a few large buyers.

This stuff isn’t for everyone, but I think there is some inherent (particularly American) desire for freedom from people looking over you shoulder, setting deadlines and making demands. And to many of us, that freedom is being a founder. Just be careful what you choose to found.

Written by Brad Hargreaves

December 13th, 2010 at 9:19 am

The Scene Will Kill You

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If you’ve taken a deep dive into tech startups, you know about the scene. The scene is the siren song of the innovation community. The scene will kill you.

The scene is building sexy things that gain the approval of a certain (small) group of people. Sexy things get lauded, and celebrities coalesce out of the blogosphere’s protoplasm. The scene builds and sells a dream. Skip to the beginning of the line; pass go; collect $200 and a DUMBO loft. Get in SAI 100, speak at conferences and spend your Friday nights at launch parties. The scene lends these things great importance. The scene assigns value to popular acknowledgement of value rather than actual value. The scene is all these things – it is at once a state of mind as well as a loose community of people in any city with a large startup community.

I will spend this weekend’s post on a warning: the scene will kill you. It will misdirect your efforts and focus your attention on the cool and the shiny rather than the substantive. Your product will be driven by the spotlight rather than the user or the dollar. It will inspire envy of your co-founders, your friends and your colleagues.

People in the scene don’t say nice things about other people when they aren’t around. They’re too political, too strategic for that. Don’t expect these people to watch your back. If you’re in the trenches building a product or raising money, you must surround yourself with people you trust. You cannot tolerate politics and political people.

Building a startup requires blinders. Fred Wilson is right — being agnostic to the zigs and zags of competitors is critical. But it’s not just about ignoring competitors; it’s about identifying fads and unproductive behaviors and mercilessly cutting them out of an organization. And if you don’t do it, someone else will — and they’ll have a competitive advantage, whether for market share, talent or financing.

The scene provides a useful disguise for wannabes and dilettantes. The back-biting and politics of the scene enable B- and C-level players to skip from venture to venture, destroying value and poisoning relationships.

The scene is why I enjoy hanging out with developers. Developers/engineers tend to be grounded by a sense of the inherent usefulness and value of products. In a city like New York that is swimming with smart, non-technical entrepreneurs, it’s surprisingly easy for an entire community to be distracted from building meaningful things that tackle real problems. The webutante is dying, but not quickly enough.

The scene will kill you and your company. That’s as clear as I can make it. The scene is the antithesis of innovation and collaboration. Avoid political people and cut them out of your organization wherever you find them. This won’t necessarily make you successful, but it will let you be happy with yourself regardless of how things turn out.

Written by Brad Hargreaves

November 7th, 2010 at 9:54 am

Venture Fundraising in Four Graphs

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Relating investors on board to chance of ever closing
Comparing months you've been fundraising to your chance of ever closing
Comparing Active Investor Conversations to the time cost
Comparing Hope and Time

Written by Brad Hargreaves

July 25th, 2010 at 1:21 pm

In Defense of Lifestyle

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You don’t have a company. You have a job.

- Yale prof and Honest Tea founder Barry Nalebuff, to me, September 2006

I was in college at the time, running a small antique furniture reseller called Aloysius Properties on the side. Aloysius was a fun business. We realized that Ivy League schools, especially our own Yale, were selling their turn-of-the-century-era wood furniture at fire sale prices as they renovated libraries and classrooms. Aloysius bought as much as we could get our hands on and sold it online at significant markups — a 20x multiple wasn’t uncommon in addition to a 15% shipping and handling fee. And our customers (almost exclusively wealthy southern women) were thrilled to have these pieces of academic history.

It was very much a lifestyle business in every sense of the term. Specifically, the founders (Matt Brimer and I) wanted a business that threw off a decent amount of cash with minimal hourly involvement — that is, a business to support our lifestyles as college students. And it was a total break from our college lives spent staring at books and screens — buying furniture out of university warehouses, physically moving inventory, talking to customers and coordinating shipping was different and exciting.

But this kind of business went over with the pre-Lehman Yale crowd like selling crack in New Haven grade schools. It was gross, physical labor — a waste of our precious mental resources that would surely be better spent pricing derivatives or being flown around the world by McKinsey. In more precise terms, Aloysius would not get one laid.

The university did have a nascent startup scene. Innovation was encouraged, and traditional jobs in high finance and consulting were held in slightly less regard. But there was a parallel problem in the Yale startup community, one that effectively took the place of the larger university’s fetishization of high finance. There was the palpable sense that unless you raise significant capital, you’re not running a real business.*

This left Aloysius high and dry. Matt and I abandoned the business in early 2007, choosing instead to focus our efforts on raising venture capital for an online gaming startup, GoCrossCampus. Things didn’t turn out badly — my next company, PayoutHub, was acquired earlier this year, albeit not for fuck you money.

Since then, I’ve slowly getting back into “lifestyle-like” cash flow businesses. It’s entirely possible that I’ll see an opportunity in a company to take it to the next level and scale it into a venture-fundable blow-the-doors-off next-coming-of-facebook success. But I don’t have to, and there’s nothing wrong with covering my downside by starting with the goal of building profitable companies and seeing where it goes from there.

As a caveat, scalability of personal involvement is important. This is the difference between a job and a company — and helped spell the doom of Aloysius. Aloysius Properties was not only a personnel-heavy business, but it would’ve been difficult to pass off to an intern with minimal instruction (my litmus test for cash flow businesses). If you can’t pass it on to an intern with fewer than a few hours’ per week involvement, it’s probably a job. As you might imagine — and contrary to our beliefs at Yale — the litmus test has nothing to do with raising venture capital.

* Over the last few years, the Yale Entrepreneurial Institute has done a great job shifting this culture. One of last year’s businesses was a grilled cheese restaurant. Cool.

Written by Brad Hargreaves

July 18th, 2010 at 1:45 pm

Is Tumblr the new 4chan?

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I’m not sure anyone who reads Startup Adventures has been paying attention to the sad story of Jessi Slaughter, 4chan’s latest tween meme-toy, but you can read about it on KnowYourMeme here or ED here (NSFW). It’s a fascinating story about the fluidity and power of the anonymous web, but a couple points in the articles particularly stuck out:

From KnowYourMeme:

The effects of her videos being posted to /b/ and various Tumblr blogs brought out the best of Anonymous, who began trolling her with taunts of her being stupid and ugly. She replied with comebacks that had little effect on the trollers.

From Gawker:

Here’s how the Internet’s rage—funneled by Tumblr and 4Chan’s infamous /b/ board—ended in this sad and ridiculous scene.

From ED:

She also seems to be an underage b& lurker or a total Know Your Meme n00b, due to her knowledge of several memes. She is the latest target of tumblr’s and /b/’s ire.

Call me old or out of touch, but what the hell, Tumblr? 6 months ago, this would’ve been attributed to “4chan” or maybe “4chan and eBaumsWorld”. In my world, Tumblr is the happy realm of new media hipsters — artists, designers, entrepreneurs and urbanites posting the latest LCD Soundsystem track.

When did it suddenly become Encyclopedia Dramatica with more whitespace?

I get how it works — Tumblr has taken serious VC money from some of the best consumer web investors on the east coast, and they need to continue to grow by orders of magnitude to justify the capital and achieve a proper venture exit. David Karp’s a smart guy, but I have to believe that this kind of growth will constrain the company’s ultimate value. There are a lot of reasons why Chris Poole has difficulty monetizing 4chan, but I don’t think it’s for stupidity or lack of trying. It’s just hard to make money off Anon.

Perhaps this is still a really small segment of Tumblr’s community. But given the natural virality of the platform, I would be seriously worried about these elements polluting the rest of the site. Don’t get me wrong, I believe the anonymous web is generally a Good Thing. I’m just not sure it’s a good business.

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July 16th, 2010 at 2:35 pm

Why They Don’t Answer Your Emails

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Occasionally, people don’t answer my emails.

Realizing that this is a fact of life — and an inevitable part of being an entrepreneur — has been one of the toughest things to wrap my mind around. When I was getting started, it was an insult. I came straight from a world (college) where people received possibly twenty relevant emails a day, and not answering any one of them was an intentional slight. But realizing that the startup world simply doesn’t work this way this was step one.

Step two — which is still in progress — is figuring out why people don’t answer my emails. That’s what this post is about.

(Step three, for the curious, is not answering all of my own emails. I’m really sorry.)

These are observations I’ve made from years of “warm” emailing acquaintances, potential partners, investors and people I met at conferences. This isn’t about cold emailing or email campaign optimization. I assume those people don’t email you back because they don’t know who the fuck you are. As always, your mileage may vary.

Finally, “Busy” is not a sufficient reason for the purposes of this list. Everyone is busy.

1) They’re embarrassed. I think this is the single least-understood reason why people don’t answer their emails. I do this a lot, and I know a lot of people who fall victim to the same pattern. If I’ve been bad at responding to someone, and I’ve sat on an email for three weeks, the chance that I’ll respond with each passing week grows smaller and smaller. If I email them, I’ll simply remind them of how long it took me to respond. Allie Brophy mentions this in her latest wonderful post.

The Fix: Push them. I’ve found that this is often an ideal situation to suggest an in-person meeting. Coffee or drinks can be scheduled well in the future, and removing the tension of a broken line of communication may actually re-open the dialogue in the meantime.

2) They don’t want to deliver bad news. Saying “no” sucks and — in many situations — little is gained by doing it. Turning someone down is difficult, which is why many people make their assistants write those notes. If someone doesn’t have an assistant or simply doesn’t care what you think, the rejection email isn’t getting sent.

The Fix: There’s often nothing that can be done here. Gentle reminders can get you to a clear “no”, but identifying this situation early and taking the hint can save you time. That said, I think many entrepreneurs greatly overestimate how often this is the reason for a non-response. Many people assume that someone isn’t interested when in fact one of the other reasons on this list is delaying the response.

3) They’re preserving option value. This is a corollary to (2) and is very applicable to VCs, but it requires a different response tactic. This is one of the most annoying things that VCs do, but it’s actually much more common than getting a simple “no”. VCs’ reactions to most pitches fall somewhere between “I’m writing the check now” and “security will escort you from the office”. For these median cases, they’ll only write the check when they see a term sheet from Sequoia, but they’d like to preserve their ability to invest in case Sequoia actually gives you a term sheet.

The Fix: Convince them that the train is leaving the station — they should make a decision or forever hold their peace. Investors are coming in, a strategic is interested, the round closes on X date, etc. This is hard to do but is really the only way to get out of this hole. But do it quickly or else the deal will get stale.

4) There isn’t a clear ask. I occasionally get messages that I’m not sure what to do with. Am I supposed to respond to this? Forward it? RSVP to an event? Help me out here. If I’m not sure what I’m supposed to do, I’m probably not going to do anything.

The Fix: Clearly state what you want in the first 1-2 lines of the email. It’s really that simple.

5) There’s no value proposition. Some people will do things out of the kindness of the hearts, especially for people they’ve met. Others won’t.

The Fix: I always try to tie my emails back to some kind of benefit the recipient could see down the road if they respond to my email. There are pluses and minuses to doing this — some people are more willing to help you for the sake of helping you than enter into some kind of vague trade — but in all I think it’s a positive.

6) Politics. Sounds weird to an entrepreneur, but responding to emails at-will is politically difficult in a lot of organizations. A low- or mid-level employee could get in a decent amount of trouble by even hinting at something that may not happen, whereas they probably won’t catch any flak by simply not responding.

The Fix: This is the toughest to overcome. Often it means you are approaching the wrong person in the organization, or you need to approach multiple people. Or perhaps there’s nothing you can do and you should just wait. It really varies based on the organization and situation.

Any others I’m leaving off? Why don’t you respond to emails, fair reader?

Written by Brad Hargreaves

June 20th, 2010 at 2:01 pm

Incentives and Carried Interest

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The House recently passed a bill to tax carried interest at the higher income tax – rather than the lower capital gains – rates. This has generated considerable consternation and debate in the venture world and somehow led to Chris Dixon asking Jim Robinson to go fuck himself [1]. In brief, taxing carried interest – the “profit share” that money managers take from any positive returns they make – at income tax rates would increase the tax burden on VCs and possibly lead to changes in the way VC funds are structured. Some smart people think this is a good thing, as it seems a bit silly for money managers to receive a government subsidy at a time when there are so many money managers.

Let me add some thoughts into the mix [2]. First and foremost, I don’t really buy the argument that taxing money managers at a higher rate will directly lead to a decrease in capital flowing into funds. Pension funds, endowments and high net worth individuals still have lots of money, and they’re willing to pay someone to manage it. I may be wrong here, because I don’t pretend to understand all the subtleties of the system, but this is not the argument that speaks to me.

But I do believe that people respond strongly and (fairly) efficiently to financial incentives. Over the past two decades, some of our nation’s smartest people have gone into banking and private equity because you can make great money there. If science and engineering had the same compensation structure and magnitude as high finance, we’d have a lot more scientists and engineers.

Fred Wilson uses this argument as he writes in favor of taxing carried interest at a higher rate. If it were less lucrative to be a money manager – the result of this tax increase – fewer of our best and brightest would become money managers. On the surface, that seems like a good thing. And it may be. But one of the things that makes the American startup scene great is the number of smart VCs out there. Sure, VCs come in many flavors – some are brilliant folks dedicated to supporting entrepreneurs, and others are idiots. But the last thing we need is to turn VCs into mutual fund managers – the bottom of the financial hierarchy with minimal alignment with their investors or incentive to perform. Mutual fund managers don’t take carried interest, just a management fee. Because of this and other factors, mutual fund management is one of the least lucrative executive positions in finance and is staffed accordingly.

I don’t want to see venture capitalists without significant carried interest – timid, risk-averse and totally misaligned with the interests of entrepreneurs and LPs. This will inevitably lead to lower returns – and an eventual decrease in money flowing into venture capital, and by association, startups.

Money managers are given the task of allocating the free world’s capital. Their decisions of where to put that capital to work have an overwhelming effect on our nation’s growth, development and standard of living. There’s a strong argument to be made that they’ve been doing a terrible job of late – rather than investing the past decade’s excess wealth in infrastructure, science and technology, they decided to build houses in suburbia that now lie vacant, rotting in the Sun Belt summer. There’s a growing body of research showing that this choice will have a significant impact in our nation’s economic growth and competitiveness for decades to come.

I want the smartest people in the world deciding which companies have a chance to succeed or fail. There’s a problem in money management, but I’m not sure increasing taxes on the managers’ incentive to succeed is the right answer.

[1] Matt Mireles’s post on this exchange is totally worth reading.

[2] I don’t really have a dog in this fight. Tipping Point doesn’t manage a fund of outside capital, and thus we don’t make any money from carried interest. I don’t personally invest in venture-fundable companies, so I’m not secretly hoping that VCs get weaker so I have access to better deals. I really just want to see a thriving startup ecosystem that leverages technology to drive fundamental change.

Written by Brad Hargreaves

June 13th, 2010 at 10:13 am

Sources of Capital, by Google Hits

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Search: “Funded by {x}”

{x} = Venture Capital
45,600 hits

{x} = Private Equity
34,500 hits

{x} = Friends
24,400 hits

{x} = Family
19,900 hits

{x} = Angels OR Angel Investors
13,900 hits

{x} = the Devil
4,020,000 hits

Protip: Startup capital can be hard to come by. VCs, angels, friends and family and Lucifer the Archangel are all sources worth exploring.

Written by Brad Hargreaves

June 4th, 2010 at 11:19 am

Why Everyone Should Get Funded (Once)

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The smart money says there’s plenty of capital out there. And from the perspective of near-term return optimization, they’re right. In fact, there’s probably too much capital out there, especially in major centers of innovation like New York, Boston and the Valley. If you were to seed fund the “marginal 10%” of companies — the companies that barely miss the current threshold for funding, if such an objective measure were to exist — the financial returns would surely be dismal.

But that’s not the only way to look at it. I argue that — from a long-term perspective — more companies should get funded.

Running a funded startup is an incredible education unlike any other. As someone who has run (a) bootstrapped startups that I couldn’t get funded, (b) bootstrapped startups that purposefully didn’t raise money, (c) angel-funded startups and (d) venture-funded startups, the learning experience delta between {(a),(b)} and {(c),(d)} is incredible. Taking money increases the volume of things going on and pushes your company to the next level. It increases the amount of stuff you have to figure out. It opens doors and enables conversations that few bootstrapped startups can have. If you pick the right investor and leverage it, the things they say about “opening their rolodex” can absolutely be correct. And you learn a lot of critical stuff about how to build a business from those people. Even taking “dumb money” can make it an order of magnitude easier to get in the door.

And most importantly, it’s a guaranteed lifetime addiction to entrepreneurship.

Even if the companies built with this seed money don’t succeed, these entrepreneurs are the foundation for successful companies in five or ten years. Every entrepreneur that fails to raise money and is forced to go back to the day job is a potential groundbreaking innovation that will never see the light of day. Claiming that “real entrepreneurs will always persevere” is bullshit. The people who create awesome, world-changing things are not always the people who are willing to work eighteen hours a day for no salary for years. They may be people without savings, with mortgages and with families. Creativity and innovation isn’t the just domain of scrappy 20-somethings, so why is entrepreneurship?

In economic terms, there’s a huge positive externality to all of this connecting and learning. That means that more of it should happen than will actually happen if every player is simply looking to maximize profit. If more startups are going to get funded, investors must believe in the positive social benefit of funding.

And I think it will happen. The comps are changing — more wealthy independent investors are looking at seed funding as philanthropy rather than a component of a diversified investment portfolio. A certain group of investors are considering their seed investments in the same pot as their patronage at the Met or contribution to an off-Broadway production rather than their private equity assets. This is a really, really important distinction, as it makes the returns of these capital deployments less of a factor. Wealthy independent investors aren’t blind — they see need for funding and innovation as the savior of our nation and economy. This isn’t just an investment; this is a moral imperative. And you can’t ignore the sexiness and cocktail party benefit of being in on the ground floor of a new hot startup.

There are good counter-arguments to be made here, but I think they are outweighed by the curation of a future generation of entrepreneurs. For instance, it is absolutely true that more capital will lead to more competition for the means of production (e.g., developers), driving up prices and making it more difficult for “good” startups to hire. This is absolutely true, but higher salaries for developers in startups isn’t a bad thing for the startup environment as a whole. After all, the world — even the world of hackers — operates by the rules of supply and demand, and higher salaries from startups will draw more developers from established tech companies and banks, for instance.

Seed funding is entering the world of philanthropy, and I think it’s a very good thing.

Written by Brad Hargreaves

May 16th, 2010 at 3:39 pm