You’d think most entrepreneurs would follow the Facebook formula for success. Take an idea, bankroll it with venture capital, and float an initial public offering worth billions of dollars. But that’s not what every start-up wants. WNPR’s Sujata Srinivasan reports.
It’s almost a rite of passage for companies to raise venture capital. In addition to large infusions of cash, venture capitalists – or VCs – provide entrepreneurs with a team of experts whose goal is to multiply the start-up’s valuation by as much as ten times. The higher that number, the more money a VC makes when it sells the business, allowing it to make up for the many investments that typically don’t work out. But for some entrepreneurs, chasing VC paper valuations is simply buzz and noise. The real deal is to create a product that customers value. And that, they say, comes from a culture of bootstrapping.
“I think if we had had venture capital money early on, we would have failed. I don’t think it encourages the level of innovation if instead there’s always money to be relied on. There’s an efficiency that comes from poverty.”
That’s Matthew Wallace, president of VRSim in East Hartford. His company develops virtual and augmented reality training systems for clients such as NASA. The company became profitable in 2005, four years after it was founded, and is fully funded by revenue.
“I’m willing to take our stuff forward and spend six years getting to a market, not three years. And I think that difference allows us to create a more robust, deeper dive into the knowledge in that particular area.”
Wallace says that approach taught him and his 13 employees to really understand what the customer wants, although the process was slow and cash was tight. Wallace provided the bulk of VRSim’s investment capital and angel investors chipped in less than $200,000. By contrast, VCs typically cut large checks upward of $1 million. Like Wallace, Bala Krishnamurthy of Aeolean wants customers – not VCs and stock market investors – to validate her product. But that, she says, requires a level of freedom, which VCs don’t allow.
“I don’t want to have somebody else call the shots. We really want to figure out things for ourselves and yeah, you will make mistakes. But we’ll learn. The first question they’ll ask is ‘What is your exit strategy?’ I don’t even know if I have an exit strategy. I enjoy what I’m doing. I’d like to develop more and more products.”
Aeolean in Ridgefield develops software solutions for businesses in the U.S., Europe and Asia. Krishnamurthy founded the company nearly 17 years ago with $30,000. In the early days, she paid employees from her savings but did not write herself a paycheck. In the absence of a VC team of experts, she turned to industry advisers for guidance. Ross Kudwitt of Crisply built a product and a market before deciding to raise VC money. This would eliminate quite a bit of risk for the VC, so Kudwitt can retain a greater share in his company. The former Timex chief technology officer invested close to $ 1 million of his money in the time-tracking software start-up founded two years ago in Woodbridge.
“We knew we could build a great product and we didn’t want the pressure early on from investors pushing us to go after revenue or build a sales force or build a support organization or create partnerships before we were ready with our product.”
Connecticut Innovations – or CI – a state-funded organization in Rocky Hill often works hand-in-hand with VCs. President Peter Longo says VCs help start-ups to scale up quickly and reach large revenue milestones.
"It really depends on what the goal of the founders of the business are. If they’re looking to create a $100m company or beyond, then venture capital is something that will probably be a necessary evil that they need to take. If they’re happy building a nice little business that maybe can grow to $5m to $10m in revenues, then they probably can bootstrap that business.”
But Longo agrees that when VCs step in, entrepreneurs could give up quite a bit of their freedom.
“The reason venture capitalists invest in these companies is to generate returns in a timeframe that’s set out within the document. Sometimes that could inhibit the ability of companies to do research, development and innovative things.”
But it doesn’t mean that bootstrapped companies aren’t driven to grow quickly. Because they rely on their own funds, such companies are forced to reach revenue targets so they can stay in business. The tension between entrepreneurs and venture capitalists may deepen along with the economic recovery. VC funds are growing in size from $100 million to $500 million. So they are writing bigger checks and returns from start-ups need to be large enough to support the fund. Konstantine Drakonakis is a director at New Haven venture firm Launch Capital.
“The funds are getting bigger and the checks have to be of such a size that they do tend to drive the companies toward much larger exits. And you just need to be aware of that.”
At the same time, smaller VC funds like Launch Capital, which target less capital-intensive start-ups, are also growing in Connecticut. Drakonakis says the key is for entrepreneurs and VCs to share the same core values and beliefs. If there isn’t a good fit, then perhaps entrepreneurs should consider other funding sources – angel, grants, small business loans, family, friends, or good old-fashioned bootstrapping.
For WNPR, I'm Sujata Srinivasan.