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Fixing Venture Capital Article

(Couldn't find a 'Discuss this article' link on the page, and I don't see one in the list of topics, so I'm arbitrarily starting my own damn topic to ask a question:)

Christo Fogelberg
Wednesday, June 4, 2003

Joel mentions three books and two blogs themed around VC... but doesn't mention any to do with the non-VC or Ben-and-Jerry way of starting up a software company. Has anyone read or found anything relevant to this way of doing things?

(Random Addendum: I've read High St@kes, No Prisoners too - it's worthwhile reading if you ever want to do the entrepreneurial thing:)

Christo Fogelberg
Wednesday, June 4, 2003

Great article Joel.

John Rosenberg
Wednesday, June 4, 2003

Interesting analysis (as always) from Joel.

Only question is: What's the alternative ?

I guess self-funding is the best way to go for many cases (that's what I'm doing), or perhaps a loan from a friendly bank (friendly compared to a VC at least).

Anyone care to share their experiences of growing software businesses, wither with or without VC support?

Steve Jones (UK)
Wednesday, June 4, 2003

Good, straightforward, article, given the target audience, but it shouldn't be news to anyone (anyone who's seriously looking for funding) that some VCs rather like the all-or-nothing business plan.

"I don't want to invest in nice little companies" was how a guy I was talking to the other day put it. And fair enough, in my opinion. You want a secured loan for a small amount, go talk to the bank - that's what they're for.

But entrepreneurs do need to know that this is the state of play, so good one JS for explaining it so clearly.

Oh, and one upside of the recent slowdown in VC investment (at least here in the UK) is that VCs are more willing to 'dance' now.

Able Baker
Wednesday, June 4, 2003

Where to begin?  As an entreprenuer who has considered the VC route, this article really struck a nerve.  I think Joel is mostly correct about this and I think that VCs have several other perverse incentives which make them a problem in the entreprenuerial process in many, but certainly not all cases.

The most signifigant of these, I think, is that the VC has no incentive to create a company which will be profitable in the long term.  Their incentive is to create a company which looks like it will be profitable long term, at about the seven year point.  You would think that actually creating a long term profitable company would be the best way to do this, but in reality it is not.

Of course, in defense of the principle of VC, I must point out that because of the VC explosion in the late nineties, most of us have as examples, some pretty poor quality VCs to look at.  There were just too many people trying to be VCs and the average quality just had to suffer.  I had always read that a proper VC wasn't just a source of money but that he, and your board would offer advice and guidance.  Judging by many of the amatuerish decisions the start-uos I have worked for made, this system just wasn't working in the late nineties.

Another problem I have with VCs, is the same problem most people have, they see what they do as the most important part of the process.  You will here it again and again- the most important think is the managment team.  They will tell you that they would rather have an "A" management team and a "C" technology than the other way around.  That can't be right, can it?  I mean, I agree the management team should be great, but what are they going to do with crap technology?  I think that to be successful all aspects of your business need to be pretty good.  This attitude (not limited to busienss types, BTW) that what I do is the tricky part and everything else just falls into place if you spend the money, is absolute non-sense.

Another thing that drives me nuts, is the VCs (and angels to some extent) that they own the process and that the silly little entreprenuer only disagrees with them through lack of experience.  I have read and heard it again and again, VCs and angels saying the biggest problem is that entreprenuers over value their companies.  Get it?  Every startup has an intrinsic fair valuation which is known to the potential investor, while the guy who started the company is all caught up in emotion and cannot fairly value it.  It's not that the principle of supply and demand enters into things or that one party has a price he is willing to pay and the other has a price at which he will sell;  There is a correct price which the VC knows and the entreprenuer must be carefully educated for the deal to move forward.

BTW, I'm not sure this still goes one, but in the recent heyday of VC, didn't these guys make a butt-load of money just for holding on to (er- managing) funds which had not yet been invested?

This is not to say that VC is all bad.  There are many types of companies for which VC funding is the correct way to go.  There are many for which it is not, including those great little companies which expect to make a modest return over a long period of time. VC is necessarily based on the rare big score and can't really work any other way.  For smaller ventures you really need an angel or two.

What I would be interested in seeing is a study on the success and failure rates of VC backed companies.  I have had business people tell me that giving most of you company to a VC with the hopes of it increasing rapidly in value is just the way businesses are built these days, but is it?  What percentage of the fortune 500 were built this way?

My apologies for the long post- this one just stuck in my craw.  It kinda hurts.

Erik Lickerman
Wednesday, June 4, 2003

Google is one company where the VCs seem, repeat SEEM, to be in it for the long run. Whenever they're being interviewed Sergey, Larry and Eric all deny an upcoming IPO. They often say they haven't even started discussing it.
Maybe Kleiner Perkins have made some secret lucrative deal or maybe it's Google's unique way of doing business, I don't know, but it looks to me like they've got a different deal with the VCs than most other computerrelated companies.

Rikard Linde
Wednesday, June 4, 2003

I have the same feelings towards VCs as Joel. 

What else to do?  Be self sufficient.  That may mean putting a really big idea on the back burner if it's capital intensive up front. 

Banks?  Trust me, banks only loan money to businesses that don't need it.

Sam Jurgensen
Wednesday, June 4, 2003


Take a look at a book called 'Growing a Business' by Paul Hawken.

UI Designer
Wednesday, June 4, 2003

Another good book that develops Joel's "Ben & Jerry's" approach is "Beyond Entrepreneuship: Turning Your Business Into An Enduring Great Company" by Collins and Lazier.

I too believe that most businesses should be grown incrementally from cash flow to maximize chances of success. However, there are some exceptional cases where VC money makes sense-- Federal Express (requires huge infrastructure to get started that could only be developed with outside money) and Amazon (needed to develop a brand quickly) are two.

Joel, I like your time plots of a growing business. There's a simulation called "Boom & Bust Enterprises" that dynamically develops similar behavior for a growing business (showing the trade-offs in capacity, pricing, marketing). If you like, you can try it at: 

Michael Bean
Wednesday, June 4, 2003

Strange. The URL I posted in the message above doesn't seem to work. Try:

Michael Bean
Wednesday, June 4, 2003

It is a good artical but missing a point reiterated in an earlier  point.

I'll reiterate it a bit diferently...

The VC's _sole_ interest is in making the VC money in the short term. They do this by _selling_ the impression of "long term" profitability. This impression might reflect the truth but it could reflect pure fantasy.

Most, not all, founders's interest is in creating a sustanable business (in fact). This may be a sufficient property but is not necessary.

Some founders do have the _same_ interest as the VC (namely creating an impression of long term profit that is not real).

The VC business is a bit like a pyramid scheme in that the earlier participants make money and the later participants don't (always in a pyramid scheme but sometimes in a VC'd business).

Another example is that some businesses are organized to produce "attractive" crap that they plan to sell only for a short period (e.g. "as seen on TV" garbage).

Wednesday, June 4, 2003

I've found these two points among the thread, but wanted to lay them bare. And baseball's cool. Stripping out all the charts and Graphs, the article makes two good points.

1. The way that business owners define success is different from the way that VC's define success. A business owner (in Joel's estimation) defines success as sustainable growth that yields a company with longevity. He wants base hits. The VC's (in Joel's estimation) define success as money earned on the company-as-product. They want home runs.

2. The way that VC's mitigate risk (increase "success" chance) is very different from the way that owners mitigate risk, and that difference leads to conflict. VC's mitigate risk by owning multiple teams, one of which is sure to win the world series. Business owners mitigate risk by growing and developing the one team they are responsible for, hoping to be home-town darlings and win game-by-game.

Daniel Mehaffey
Wednesday, June 4, 2003

There are two other points of tension between the startup committed entrepreneur and VC capital.  The classic VC curve for software companies is 5 years.  That is the VC will support losses for around 4 years so long as they can float the company in the fifth year (there are multiple rounds of finance on the way to the 5th year).

As Joel says, ten years is a more reasonable time for software to actually both become stable and profitably saleable.  So trying to meet a 5 year cycle just pushes those other curves, its another pressure to over hire and grow too fast just because there is VC capital involved.

The other point is that the ultimate aim of the VC is to sell the original stake for a bumper return, either by flogging it to some other even riskier VC or going the IPO route, going public.

The last thing the original creators are interested in (if they are committed entrepreneurs), is flotation.  Employees can get excited by IPO (well the first couple of times they get sold that pup), but the original owners are giving away everything they created in the first place.  Now if its successful they have a huge paper return (which they can't really cash in without throwing the baby out along with it), but they get a whole squadron of major investors peering over their shoulders, and they are far worse than VC auditors.

Simon Lucy
Wednesday, June 4, 2003

I completely agree with this article.  Joel has summed up my experiences with VC's far better than I could have done.  I definitely council against VC funding at any startup I work for, unless it's really neccesary (ie you can't generate a revenue stream without it).  The vast majority of VC's have little buisness expertise to share and can be likened to a lead weight around the leg of a swimmer.  There are good VC's out there, but unless you get lucky or they approach you, it's unlikely you will have an opportunity to do buisness with them.  I certainly wouldn't build a strategy around getting a good VC firm.

Brian Niemeyer
Wednesday, June 4, 2003

If employees (or anybody) is excited by an IPO, they are interested in the short term prospects (i.e. they are largely indistinguishable from VC's). If they are interested in getting a wad of shares (that will have long term value), then they are "founders".

Wednesday, June 4, 2003

Erik - a *true* "A" management team will have "A" technology. They'll be able to hire and retain excellent coders who can create the "A" tech you need.

The trick is - do not confuse an "A" salesman who's a "D" manager with a true "A" manager.


Wednesday, June 4, 2003

Sometimes, well quite often in the past, employees have been enticed on board startups with the promise of Founder shares and an IPO valuation plucked out of the air, and in return taken a hit on pay or contract terms.

Simon Lucy
Wednesday, June 4, 2003

Joel made very valid points in hisessay. This brought up a couple of questions:

1.) Aren’t angel investors bit different from VC’s? Don't they (Angel Investors) align themselves more with the founders?

2.) Since most of the Venture capital firms hire people who have founded successful companies why do they still align their goals, in this manner?


Prakash S
Wednesday, June 4, 2003

what i didn't understand about the VC as a concept (and the article).

- whats the point of their policies - they are bound to run down _all_ the companies they own, and ruining all the capital they have is also not their objective.

In the current economic climate the likelyhood of some place making it like Netscape is 0; so holding on to the old game looks like a loose - loose situation.

In other words, why didn't VC change as a result of the slowdown?

Another question: there seem to be more VC holdings than Netscapes, so how did the remaining VC holdings manage to survive the apparent lack of Netscapes?

Michael Moser
Thursday, June 5, 2003


I agree.  You cannot be considered a good management team if you don't know how to evaluate, hire and retain "A" people in most parts of your business (not just tech).  This, I suppose, is why it is nauseating/ironic that angels say they would rather have "A" management and "C" technology.

Erik Lickerman
Thursday, June 5, 2003

A lot of enterpreneurs who become VC partners are "serial enterpreneurs" who have started a bunch of companies. The've have learned that it's much more profitable (and easier) to start a company, get it off the ground a bit through whatvever means necessary (inflated revenues, PR, employees), and cash out. Very few of these people have ever seen a company through long term. These people aren't that different from VCs.

One or two early successes are enough to set you up so that you can keep trying to hit the home run again with the next startup. You can't be completely stupid or you'll just waste away your bankroll, but you can definitely try to reduce the risk by trying a bunch of times. VC model works extremely well for these kinds of enterpreneurs because no good gambler in his right mind would want to bet with his own money.

On the other hand, if you're interested in building a company for the long term, VCs are not the best option for all the reason Joel listed.

Thursday, June 5, 2003

One reason VCs look for "A" team rather than "A" idea is that world changes pretty fast. Something that was "A" idea today, could be wrong tomorrow. Or your idea may look great on paper but may not fly in the market in the first place. Even if your idea works, you'll need to expand your product line and market to grow. A great team can adjust to these problems, while a mediocre team will just get bogged down.

Thursday, June 5, 2003

The reason for backing the best teams (which really means having a track record), is that they deliver.

Now, given a lead weighted sow the best team in the world might fail, that's less important.  What is important is that the risk is minimised by having the best team.

Simon Lucy
Thursday, June 5, 2003

There are two key reasons why without an "A" management team, you're screwed:

1) Having a few bad employees rarely ever destroy a company. If nothing else, they just don't have the reach of influence and power required.

Bad managers, however, can crush even the greatest of Big companies in pretty short order. They can illiminate morale, implement a system-wide paradigm of perverse incentives, fire the best and most experienced employees, explode a brand name into a worthless string of letters, and many other such horrifying hair-raising things.

Bad employees and bad technologies can be recovered from, typically. But bad'll not likely survive long enough to put up much of a fight, depending on the business and it's environment.


2) If you look at all the successful people and companies in the world, you know what you'll often find? Their first ideas failed. Their original plans had to be disgarded or changed beyond all recognition because conditions changed or they just plain didn't work.

In might turn out that your A technology turns out to be a dead-end bust. An unforseen competitor could come out of nowhere and take you from an A straight to an F. Lawsuits, sudden changes, major evolutions or revolutions...can't predict them. And if your main value is technology in the age where perhaps the speed of change is fastest in the world?

Good management, however, by definition must be capable of dealing with major changes effectively. Products and campaigns fail all the time, yet good companies must survive them and constantly seek to improve. Example: New Coke. Whoops - yet I don't know of many people who are betting Coca Cola will fail.

Of course, this is all rather begging the question. If one could really indentify A-anything reliably and consistently, one wouldn't be worried about wasting money, because one would have approximately infinate supplies of it.

Tuesday, June 10, 2003

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