June 15, 2009
In Seattle we have a very active start up entrepreneurial community with many great resources for news , debate , education , and discussion . Recently there has been a rash of rather public debates about the virtues and implications of Bootstrapping your business. This debate has, unfortunately devolved on occasion into a bit of mudslinging.
At a recent Seattle Tech Startups presentation, Jeff Lawson of Twillio wrapped up his talk on cloud computing with a rather funny send up of quick one-liner answers to every question ever asked on the Seattle Tech Startups mailing list.
Of course what Jeff intended as a joke about common threads that never seem to end, turned into a giant thread that never seemed to end .
Although I ususally try to stay out of the mix on these often zealot-like arguments, there was one message from a local VC, who I know and have worked with in the past that seemed to get lost in the shuffle. And I was simply compelled to respond and explore his point more deeply.
My reply: More on the Bootstrapper Debate
I had decided to sit back and watch this debate from a distance because, as Jeff pointed out in his slide deck that started this most recent thread, this is just one of those classic "arguments" that erupts every couple months on the list and never really changes or evolves anyone’s opinions. So why add to the noise?
But there were a couple really interesting things that Bill mentioned last week that stuck with me. And after chewing on them for a couple of days, I thought I’d try to turn the spotlight on a couple of commonly held believes that I believe may warrant a closer look.
Date: Fri, 12 Jun 2009 18:33:39 -0700
From: "William K ‘Bill’ Bryant"
…when investors (VC or angel) describe a business as "lifestyle", it means "the business isn’t designed or intended to scale to a level that would justify outside investment, given the inherent risk of making an investment in a young company and the need for that capital to generate a high rate of return on a risk adjusted basis".
I appreciate that Bill as an investor is trying to be incredibly candid and direct here. One of the things I really admire about Bill is that unlike 99% of the investors (particularly VCs) you will meet, Bill will give you the straight poop! He won’t sugar coat it. And, I think he’s also willing to listen when people are direct (back) to him as well. So with that in mind, I’ll take a stab at dissecting his comments a little to get to an even more basic analysis.
Let’s be honest: "…the business isn’t designed or intended to…" should read "… the investor, based on their analysis (exhaustive or cursory) has reached an opinion that the business doesn’t meet that investors criteria to…"
Most investors do very very little analysis to understand what that business is actually intended or designed to do. Most investors make their initial decision based on a very simplistic pattern match. That pattern matching algorithm certainly looks for basic "scaling" traits in a business (in fact Bill does a great job of outlining them below)… but they rarely actually spend enough time doing diligence to actually determine the "intent and design" of a business.
There isn’t anything explicitly pejorative about the word; its simply a factual statement that the business is…
I’ll take exception with the use of "factual statement"… but if we tune it to "opinion of the investor" then… yep, agreed 100%. And of course, these investors don’t mean it as a pejorative… because VCs and Angles never ever want to insult you as an entrepreneur, because they don’t want you to cross them off your list if you DO come up with a business they want to invest in. They use ambiguous code-words like "lifestyle" because they’re hoping you won’t be insulted by the term.
But the business isn’t one where an "asset" or "enterprise value" is being created that would allow for an outside third party investor to invest and get an acceptable return.
Ahh! Now, here’s a really important gem. We should all take a second to look over and understand. Are you creating something, some (non-cash) "asset" that will provide greater "enterprise value"? This speaks very directly to Jeremy’s point that if you take outside third party money, they are only going to be interested in investing in your company if you can grow your enterprise value (Enterprise Value: it’s the "sellable" value of your company less your cash and or other tangible assets. For public companies it’s easy to determine, Market Cap less Cash). Have you ever wondered why a public company can have Market Cap that is less than their current cash position? Because investors are betting that their enterprise value is less than worthless. You could be raking in the cash, but still have a business with zero EV.
ALL outside investors want return. All growth oriented investors (e.g. Angels, VCs, others) want capital gains based returns. That’s why they don’t want you to have an S-Corp (profits must be paid through to common share holders). Some outside investors would be willing to take solid dividend returns (which certainly could be done with a business with minimal EV), but those types of investors are not Angels & VCs and they are not going to invest in your risky as of yet not profitable and established business.
For example, you and your friend decide to start a web design shop. It generates $185,000 per year, enough to keep the two of you more than busy and making a decent wage. Neither of you have a desire to expand the business beyond what the two of you can support. That is a "lifestyle" business.
Great description of a lifestyle business. But let’s be blunt, no VC ever takes a meeting with these guys. Not even if they’re their best friends. The most important part of this description is "Neither of you have a desire to expand the business beyond what the two of you can support.".
Here’s a clue entrepreneur: if you’ve ever thought to yourself I only want to grow my business to $X in revenue per year and stop after that… because that’s all I want to earn and I don’t want the headache that might come along with being any bigger than that… Then you have a lifestyle business. Nothing wrong with that. As Bill mentions, that $X might be quite impressive. I know plenty of Dentists who make WAY more than most CTOs I know. But that’s a lifestyle business.
In Year 3, you invent software that allows you to build world class websites at 1/10th the cost of your competitors. Instead of licensing the software to other web dev shops, you decide to open up offices in key metropolitan areas based on this "secret sauce". You estimate that each city will cost $250K to open or a total of $5M, and each city will generate $2M by year 3.
As the entrepreneur, you now have the choice of convincing individuals in each city to forego salaries in return for a cut of the business in their locale, trying to convince a bank to loan you money based on your rich uncle co signing the loan, investing your own money by breaking open your piggy bank, or raising money from investors, angel or VC. But this is a "non lifestyle" business in that it is creating an asset that investors can see their way clear to a return from their investment.
Again, Bill does a great job of explaining why some "asset" or "enterprise value" needs to be created to get a growth oriented investor to pay attention.
For those geeks out there who love a good geeky success story, look no further than 37 signals. They almost fit this story line perfectly. At first glance they look very much like a web consulting shop. But in the process of looking pathetically unfundable, they built a platform that does scale and create a high margin recurring and growing revenue stream… with minimal increase in expenses.
But here’s the cold hard truth for you entrepreneurs out there: even if you have this "asset" as part of your design and strategy and plan from day one…. most investors won’t see it, won’t believe it, or won’t want to invest. And they will use some excuse to tell you why they don’t think the investment is right for them.
If you believe the 37 Signals guys, they will claim they always envisioned building this scalable platform from day one. Maybe they did, maybe they didn’t, I won’t dare question another entrepreneur’s creation myth, but what I do know for sure, there is no way early stage investor would have seen the forest for the trees in their initial offering and made a bet on them. NO WAY!
There are plenty of great "bootstrapped" companies that investors would love to be a part of (Dell and Microsoft being among the more prominent examples of "boot strapped" companies that eschewed early investors).
And now we get to the most important part.
Bootstrapped !== Lifestyle.
Did you notice the switch here? At first Bill was talking about Lifestyle businesses, and he did a great job of clarifying the difference between lifestyle and non-lifestyle. But you CAN bootstrap a non-lifestyle business.
Microsoft WAS bootstrapped. — I guarantee you that at no time did Bill Gates ever think he only wanted to grow the business to $X so he could sit back and live on it. He had a mega non-lifestyle vision from day one. He chose to bootstrap.
Dell WAS bootstrapped. — Have you ever listened to Michael Dell? Do you think he started a company with his name on it believing he’d just build a little lifestyle business? Uh… think again.
Choosing (or being forced) to boostrap does not mean your business is a lifestyle business. If Microsoft and Dell don’t prove that point, I’ll offer one last example:
UrbanSpoon vs. Yelp.
These two businesses are essentially the same market, very similar product offerings, and are both creating non-lifestyle businesses as determined by using Bill’s definition. Namely they created intellectual property in the form of Software that they owned outright (not a work-for-hire for their clients), and that software had the characteristic that it drives a high margin revenue stream largely uncoupled from the company expense structure.
One company chose to bootstrap, the other chose to take VC funding. One has had an exit in which the founders saw as much as a 100x return on their investment. One has not yet had an exit. Neither was a lifestyle business…. although I know (for a fact) that some investors have described either or both as such.