News

Burned up or burned out, entrepreneurs elect to get by without VC’s

Here’s one reason why venture capital investing keeps falling: A growing number of entrepreneurs are shunning venture capitalists.

By Matt Marshall
Mercury News

With enough cash to scrape by without venture backing, many veteran entrepreneurs are making do. Raising money is too time-consuming, VCs are offering terrible terms, and lower operating costs mean less cash is needed.

Others feel burned by VCs. They say some VCs pushed entrepreneurs in too many directions during the boom years, pressing them to sell products for more than they were worth, hire too many people and pitch to too many customers before they were ready.

Fred Gibbons, a former entrepreneur who lectures at Stanford University and gives advice to entrepreneurs launching new companies, calls them the lost generation, suffering from broken fortunes, egos and relationships. “There’s a bunch of entrepreneurs who felt they weren’t helped,” he says. Whatever the reasons, “they’re hiding under rocks,” he says.

Still, while accomplished entrepreneurs are finding ways to avoid VCs, the unlucky first-timers have no other place to go, and the terms are tougher now. “There’s a kind of self-fulfilling prophecy,” says Mark Pincus, an entrepreneur who is self-funding his third company, San Francisco’s Tribe Networks. “Venture capitalists end up seeing only the entrepreneurs who have no other choice than to accept these kind of terms.”

He explains how it’s done: Industries vary, but a typical example would be for VCs to negotiate a deal by setting a value of about $4 million on the young start-up. They then offer the entrepreneurs $4 million more, bringing the company’s new value to $8 million. That gives the VCs ownership of half of the company. That’s a tough deal. In 1999, by comparison, Sequoia Capital paid $5 million for a mere 8 percent stake in eToys.

“There really is no point in taking the money,” said Steve Perlman, founder of WebTV and Moxi Digital, who is toiling at several stealth projects, two of them technology ventures. Taking time to shop around for investors, and then account to them while his idea is still forming, would be a hassle, he said. Using his own money is risky, he concedes, but it’s “much more fun. . . . Instead of spending my days making presentations, I spend my days creating stuff.”

He doesn’t know anyone taking VC money for new ideas, he said.

One of his confidants is Phil Goldman, a former Microsoft executive whose Los Gatos start-up is building an anti-spam product. Costs of operating a company have dropped to about one-tenth of what they were before, he estimates, with rent, computer equipment, Internet bandwidth and workers dirt cheap.

Entrepreneurs forced to rely on VCs, he says, are unable to get VC money without months of distraction.

Take the case of Brian Begosian, chief executive of Redwood Shores’ Visto. It took him nine months to win a commitment from Oak Investment Partners, but it was contingent on him raising more money from other VCs. He raised the necessary $24 million, but then Oak sent him out again, to raise an additional $6 million. Like many other advanced companies, Visto needs the capital. “The company is building quickly now,” he said. “We require capital to continue the business.”

Indeed, many VCs scoff at the notion that start-ups can expand without capital. They say it’s popular to demonize VCs, but that VCs add value by helping provide a veteran’s advice, and opening up their extensive Rolodex. “There’s no alternative strategy,” says David Liddle, partner at US Venture Partners. “Now it’s a marathon. You’ve got to have venture guys to take you all the way.” He concedes, though, that some people are bootstrapping companies with their own cash.

Still, VCs clearly aren’t getting the respect they used to. Tribe Networks’ Pincus says a VC recently called him wanting to invest in another company Pincus helped form, Friendster, an online dating outfit. Relying on word-of-mouth advertising, and a shoestring budget, the company doesn’t require capital. But the VC asked Pincus if his team would come to the VC’s office to present Friendster.

“I had to laugh,” says Pincus, referring to the assumption that the start-up needed money that badly. In fact, Pincus didn’t even tell Friendster’s chief executive.

Similar stories abound: Paul Mercer, another former Apple engineer and entrepreneur, learned lessons at his previous company, Pixo. Each time he raised money, he had to give up more control, and that hurt when divisions arose around strategy.

His new Palo Alto company, Iventor, turned down an offer from a local VC firm, he said. It is building Java software for next-generation devices, and his small team is running at such a low burn rate that he doesn’t need more capital.

Entrepreneur Konstantin Othmer launched his company, Core Mobility, two years ago, and employs more than 30 engineers in Palo Alto working on cell-phone software. The start-up looks the part: Employees dress in T-shirts and jeans. Their dogs freely roam the halls. Rooms are packed to the ceiling with computer equipment and furniture the company acquired from five dot-com fire sales.

Othmer’s previous company, Full Circle Software, raised $60 million from firms like Benchmark and Menlo Ventures during the bubble.

This time, he hasn’t raised a dime, despite several offers. Othmer closed a deal with one customer last year and has focused on making that customer happy. He charges a reasonable price, and is already in the black. VCs, he says, would likely force him to sell aggressively to more customers, spreading him too thin, too early. “If you take VC money, you have a split focus. . . . It’s a different kind of growth,” he says.

Venture backing might help convince his customers that Core Mobility will stay in business, Othmer acknowledges. However, if those same customers knew that Core was sitting comfortably on a pile of VC money, they’d assume it was willing to provide its products for free, desperate to show its VCs it has won more customers.

Instead, the start-up has found other creative ways to bootstrap. It has outsourced jobs to cheaper labor in India. Othmer snapped up office space that came with computer equipment, office furniture and even people (who had lost their jobs, and were willing to work for him). More recently, he negotiated rock-bottom rent of less than $1.50 a square foot.

Facing a $10,000 charge by the city of Palo Alto to route a fiber cable to his office for fast Internet connections, Othmer instead relied on a 10-megabit Internet bandwidth wireless connection beamed from a friend.

That friend is frugal entrepreneur Peter Hoddie, whose own Palo Alto company, Kinoma, is also going without venture capital.

Hoddie’s previous company raised $12 million, and officially filed for dissolution last month. All he’ll say about his relationship with the VCs is: “I’m happy there are no lawsuits.”

The former Apple engineer said he’s part of a generation of entrepreneurs who had to learn the hard way about what VCs do and don’t do well. If you need money, you go to VCs, he says. But they’re not good at being patient. “They believe if you throw more people at an idea, it develops faster,” he said. “That’s not true.”

Many successful companies, he says — including Google, Netscape, Yahoo and eBay — took time to develop their offerings before raising venture capital.

At Kinoma, Hoddie says he’s happy with a slower but more sustainable pace. He retained rights to the video player technology that was neglected at his former company, has continued to enhance it, and is now licensing to Palm and Sony.

VCs, he worries, would force him to try to sell the product at excessive prices, which would drive away customers. “It would be a vicious cycle. . . . We could get so distracted trying to score some big, unrealistic deal that we could end up with no business at all.”

Contact Matt Marshall at [email protected] or (415)477-2518

http://www.bayarea.com/mld/mercurynews/business/5895529.htm

News Catrgory Sponspor:


Dorsey & Whitney - An International business law firm, applying a business perspective to clients' needs in Missoula, Montana and beyond.

Leave a Comment

You must be logged in to post a comment.