Raising capital is a funny thing. It used to be that venture dollars supported very ambitious ideas that had a wild chance at totally revolutionizing the way the world works. Now, you can’t raise money unless you don’t need the money. The ambitious endeavors are being undertaken with corporate and government backing: the rise in corporate (i.e. strategic) funds, Google X, DARPA, NASA. etc.. Which makes any logical person wonder: why raise venture capital at all?
Taking immense risk at a startup to be financially rewarded should not be looked down upon. There is no shame in wanting financial security so you can provide for your friends and family and spend more of your time doing what you want, not slaving away for someone else. How great that America has a free (but dwindling) market system to reward producers for their risks and efforts. If John Rockefeller had to make billions of dollars so that I could have access to low-cost polymers, fuel, power and medicine, I’ll gladly accept the system that provides it.
But taking the risk, spending countless years of your life toiling long hours, and then handing over the fruits of your labor to someone who’s already making millions a year by taking no risk is borderline insanity. Yet founders continue to make these decisions, despite very clear math that leaves sane people inquiring why.
I’d first like to examine OpenTable. Founded by Chuck Templeton in 1998, OpenTable was able to capitalize on the investor enthusiasm of the late 90′s, raising $48M with only a few hundred restaurant customers… you can’t do that today. But brick and mortar – especially the restaurant vertical – turned out to be more stubborn than everyone anticipated.
After nearly 12 years of work, OpenTable IPO’d in 2009. Despite debuting at a market cap of $700M, you’ll notice that the founders of OpenTable have such little ownership that they’re not even mentioned in the S-1. From personal relationships I will anecdotally mention that the founding team has less than a few million dollars in collective ownership. Fair trade for years of 15-hour days with little pay? You can decide.
More recently, Box IPO’d in 2015. After the S-1 was published, many intrigued readers took publicly to Quora to ask why Aaron Levie, Box’s CEO and founder since 2005, owned so little of a $3B company he created. Journalists inquired too, and Forbes even published a list of the investors who made more than Box’s hapless CEO. Like a stud, Aaron shrugged it off. But what about the founders who don’t make it to IPO… if Aaron’s ownership is paltry, think how bad is it for other founders who took “venture” money.
Lastly, I went ahead and searched for startups on Angelist. I wanted to see what sorts of solvency “angel” investors are looking for in “startups”. Conveniently Angelist has started a portion of the site showing completed financings; some of these “startups” will list their performance metrics, valuation and money raised.
I took some screenshots of one that I wanted to explore further. Here’s a screenshot showing the revenue growth from a “startup” founded a year ago. In the span of a year they’ve reached $1M in revenue and are projecting $4M in sales by the end of this year. I looked on Crunchbase to see if this startup had raised any previous money and it looks like they’ve reached this revenue milestone organically. In other words, they’re profitable.
For some reason this startup decided to raise money. They raised $775K for, presumably, 25% of their company, valuing the company at ~3x trailing annual revenue. Are you f*cking kidding? What investor wouldn’t take this deal with a $4M ARR pipeline? This is instant arbitrage. As little as a few years ago the average trailing revenue multiple was 10x.
It’s no wonder that founders end up with little to no ownership if they take “venture” money. Each round eats 25% of their stake, and the terms are getting such that unless you grow revenue from $1M to $100M in 3 years, investors will swoop in for non-performance and seize any vestiges of ownership you may have left.
How might this have ended up differently for Chuck at OpenTable if he didn’t take “venture” dollars? Chuck starts OpenTable. He grows it hard for three years and reaches $1M in annual revenue. He takes 20% of the company and sets it aside for employees, leaving himself 80%. In year four, Chuck is on pace to hit $3M in annual revenue.
A large company is interested in acquiring OpenTable. Chuck demonstrates his growth rate and shows the opportunity to earn tens of millions in revenue from potential customers, so he really needs to be persuaded to sell. The company gives Chuck credit for earning $3M annually. They then decide it’s worth doubling that for a control premium. Using market comparables, they’re willing to pay 10x revenue. Chuck looks at the numbers and agrees to sell for $60M. $12M goes to his employees, netting Chuck $48M (not including the government’s take).
Founders everywhere need to get smarter about finance. Unless you’re a fast growing consumer company, where “venture” dollars are essential to supporting server costs, you’re almost always better off not taking external money. If you know you can grow revenue from $0 to $100M 3 years, go raise money. But remember: “venture” investors prey on founder optimism.
Recent Comments