If you were starting a tech company in 1999, raising venture capital seemed like a foregone conclusion. In fact, things aren’t too different in 2014. Thousands of companies raised tens of billions of dollars this year, just as they did back then.
Truth be told, raising VC was a goal of ours as well when we first started out. We failed. And while I didn’t feel this way at the time, today I can say: Thankfully, we failed.
Several things contributed to our failure:
- First, none of Capterra’s founders had ever started a business before, so we had no entrepreneurial track record to point to – a substantial hurdle to overcome since investors rightfully prefer people who have experience starting a business and making it succeed.
- Second, the stock market was beginning to tank in the summer of 2000, right when we started meeting with local VC firms. A shaky economy influenced investors to scale back the risks they were taking with their money.
- Third was a lack of trust in the Internet and Internet-related companies during that time. Capterra was an Internet play, and when high flyers like Amazon were considered at risk of going under due to lack of profits, it hurt the whole industry.
- Fourth, VC firms in the DC area (where we’re based) were—and still are—notoriously cautious.
- Finally, in retrospect, Ryan (a cofounder) and I, two goofy guys in our 20s at the time, probably gave awful presentations. Whatever the reasons were, we were unable to raise money. Thank God we didn’t!
This is not just sour grapes; venture capitalists actually reached out to us to invest once we made the Inc 500 list in 2007, but by then, we had been profitable for years and no longer needed it. That said, I am absolutely convinced that if we had succeeded in raising money when we first started out that we would no longer be around today. In fact, most of the companies that I know who raised VC back then are long gone.
When a venture capital firm invests their money in your company, they want you to put their capital to work. This often means planning to spend it all within a year or two in order to accomplish your goals. If it’s a first round (Series A), the goal is typically to finalize the product and start generating revenue. The goal of a Series B round is to scale the business. The goals of Series C and beyond are simply to continue to scale the business, often involving more extreme measures such as international expansion and acquisitions.
What does all this translate to? Lots of hiring. Imagine being a 25-person company with little to no revenue. It’s extremely risky. If/when you run out of money in a year, or if you haven’t figured out how to generate enough revenue to cover payroll, you either have to raise another round of money (not easy), fire everyone who needs a paycheck, or completely throw in the towel. That’s tough. That’s why most of our VC-backed peers didn’t make it.
The investors know this, but they are counting on the outlier – the roughly 1-in-10 investment that succeeds – to carry the day. If the other nine don’t make it, oh well! (Incidentally this model is not working very well for most VCs as the returns on their funds are underperforming the public stock market so far in the 21st century.)
If Capterra had raised millions of dollars in venture capital and hired a large team, yes, there is a chance that our success story would have come sooner. But I think that would have been a long shot. Some businesses just take time — time to think it through, time for the market to catch up, time to play with the product long enough to get it just right. Throwing more people and money at the situation doesn’t always work. In fact, it can be a recipe for disaster.
In Capterra’s case, as an online marketplace for the business software industry, we needed the time because we faced a chicken and egg dilemma: Who do we go after first – the software buyers or the software vendors? No software buyers would use us if we didn’t have a website with a lot of great content. But much of that content would come from the software vendors, and in 1999, their websites were fairly horrendous (many still are). But getting the vendors to participate when we had no traction with the buyers was impossible. After all, one of the key data points they considered when evaluating new marketing channels was the size of the audience. Our audience in 2000 consisted of a few dozen people — our team and our curious family members… and that’s about it.
It took us around four years to start driving real software buyers to our website and figure out our business model. If we had raised VC money, the most likely scenarios are that either they would not have had the patience, or we would have drowned in people management issues, all while we figured out our business.
As a comparison, we actually did have a competitor that started at around the same time we did. They raised $13M in VC, hired a CEO from a big company, and ramped up to over 100 people. They actually reached $ 18M in annual revenue (kudos to them), but they never really had a viable offering. We constantly heard from their customers how awful their product was. In addition, they also had no profit margins, and by their 8th year, their revenue growth completely ended. They had to sell the company prematurely, and their revenue actually cratered shortly thereafter. A bad business/product had caught up with them.
Raising venture capital makes sense for some companies, particularly those that require a large infusion of capital at the beginning to get off the ground or those for whom scaling quickly at the beginning is crucial for success. However, I think that many tech entrepreneurs tend to overestimate these necessities at the beginning. Both scenarios are much rarer than people think.
I remain convinced that the best way to fund most start-ups is by getting customers to pay you for something. Good ole-fashioned revenue. It may take a little longer at the beginning. You’ll have to learn to live cheap and work your tail off before you can even begin to think you are succeeding. But once you get over that hump, the satisfaction is amazing, your product is real, you’re still in charge (no VCs running the show), and you’ll have saved millions of dollars along the way. And, unlike what VCs will tell you in their sales pitches, you can still grow your business to $10M, $100M, $1B in revenue – or whatever your growth goals are.
In fact, the VC industry didn’t exist until the 1960s, and then it didn’t really take off until the 1980s. Plenty of history’s most successful companies, including many in the tech sector, did not rely on venture capital to get off the ground. If/when you want to finance your way to greater growth, other alternatives such as loans and public or private equity generally carry much friendlier terms once you have a real business.
Every second that I spent trying to raise money was time that I didn’t spend figuring out who our customer was and how to build the best product for them. Thankfully, this failure in judgment was not compounded by the failure that likely would have followed a VC raise!
If you know of any or are the founder of a successful tech company that did not raise VC – particularly in their first few years to get off the ground – we’d love to hear from you. Please share your stories with me via email or in the comments below!