Do Internet Start-Ups Really Need Venture Capital?
With software-development tools readily available – and with seemingly insatiable demand among consumers for easy-to-use applications for smartphones – it continues to be easier, and cheaper, to start up an Internet or software business.
At the same time, global financial troubles have made it harder than ever for new companies to get funding from venture capitalists – who are, in turn, having trouble raising money from their limited partners.
This good-news-bad-news scenario for entrepreneurs has prompted some to ask the question: Do these start-up companies still need venture capitalists?
“VCs and founders are like two components that used to be bolted together. Around 2000, the bolt was removed,” wrote Paul Graham, a partner at start-up incubator Y Combinator in a December 2008 blog post.
“A sharp impact would make them fly apart. And the present recession could be that impact,” Graham wrote.
Indeed, strains are beginning to show in the relationship between founders and VCs as money problems loom.
At a recent tech-industry gathering in San Francisco, investors from top-tier firms Accel Partners and First Round Capital reminded a room full of entrepreneurs that there’s a lot more to the founder-VC relationship than money. Investors help company founders refine their vision, generate buzz and bring their products to market, and they should be seen as teammates, VCs said.
But this rosy picture was quickly debunked by serial entrepreneur Jonathan Abrams, founder of early social network Friendster Inc. and event-planning site Socializr Inc.
“Believing these conventional wisdoms cost me a lot of money in the past,” he said. “The real world is a lot less pretty than that utopian VC fantasy.”
At Friendster - which raised more than $20 million in venture funding from top firms like Kleiner Perkins Caufield & Byers, Battery Ventures and Benchmark Capital - Abrams was replaced as CEO as the site experienced technical problems, eventually losing ground to rivals like MySpace.
It’s a different world today, as cloud computing, software-development kits and other advancements have made it easier to start a software or Web-based business with a credit card or friends-and-family capital.
Entrepreneurs are looking at companies like Fotki.com, a Russian photo-sharing site that has been self-funded and profitable since 1998. The company is seen as a pioneer by many in the industry, as it created a working photo-sharing site long before the well-known players of today like Flickr and Photobucket.
Fotki has grown its user base to 1.4 million members – mostly in Russia — without taking a dime in venture capital.
But Igor Shoifot, Fotki’s CEO, cautions against reading too much into what his company has done.
“Once you build a theory around this, you start disregarding a lot of the truth,” he said. “This is not one-size-fits all.”
Young companies, by and large, need venture capitalists as much as they ever did, Shoifot said. While it might be possible to launch on very little, it’s hard to shine without some big names behind you, he said.
“Just look at Twitter,” he said. “And look at all the other micro-blogging companies out there. No offense to Twitter, but what’s the difference between Twitter and all these other micro-blogs? About $20 million in venture capital.”
For more perspective on this topic, we recommend reading the following blog posts:
- Web 2.0 Is A Gift, Not A Threat, To VCs (Dec. 21, 2006) - Fred Wilson of venture firm Union Square Ventures, an investor in Twitter and other Web 2.0 start-ups, writes that while you can build and launch a Web service in less than a year for less than $600,000, it costs a lot more money to “maintain it, develop it from there, deal with scalability, deal with feature enhancements, take the service in new directions, respond to competitive threats,” hire more engineers and support customer service.
-Don’t Raise Venture Capital (Sept. 26, 2008) - Healy Jones, then an associate at venture firm Atlas Venture, illustrates why most start-ups, especially in the Web 2.0 space, don’t need to raise venture capital.
-7 Great Reasons Why Not To Take Venture Capital (May 27, 2009) - Greg Gianforte, CEO of publicly traded RightNow Technologies and a serial entrepreneur, offers seven reasons why most start-up founders should avoid raising venture capital, at least in the beginning. Gianforte, who built two companies including RightNow on a no-frills bootstrap philosophy, wrote a book on the subject in 2005, at which time he detailed to us why bootstrapping is the way to go.
- My Startup Experience (June 28, 2009) - Rand Fishkin, a co-founder of venture-backed SEOMoz, makes a convincing case for taking outside capital. He discloses a wealth of information about his business and uses several charts and metrics to illustrate his points.
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