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Venture Capital: A taste for something different

Thirty-two-year-old entrepreneur Chris Hickman learned a lot at the helm of a venture-backed software company during the late 1990s.

By:
John Cook
Seattle Post-Intelligencer in NASVF.org

One of the most important lessons: Venture capital wasn’t for him.

So when Hickman founded Duvall-based SharedInk two years ago, the former Microsoft Corp. manager made a point of doing it on his own.

"I have personally stayed away from venture capital, and I have no intention of seeking any, just because I know it would hinder my options," said Hickman, whose new two-person start-up allows individuals to create customized photography books for weddings, vacations and other special events. "I wanted to get back to a tight, low-overhead business that didn’t need a lot of capital."

Hickman, who raised $24 million during a two-year period as chief executive of Viathan, is not alone in his distaste for venture capital. Several entrepreneurs who raised millions of dollars during the dot-com boom are shunning it altogether.

In some cases, entrepreneurs realize that their new businesses are simply too small to attract the attention of a venture capitalist. But others say they don’t want the baggage that comes along with a venture capital round.

Serial entrepreneur Terry Drayton, who raised $160 million for HomeGrocer.com, a defunct online grocery service, currently is involved with two start-ups.

Neither one has raised venture financing.

"I have a lot of good friends who are venture capitalists, but they just have a whole different perspective in what they are trying to do," Drayton said. "Our philosophy is incremental and learn as you go. We are very base-hit-focused, and we don’t like taking giant risks. And for a significant number of the venture firms, they are only in the home-run-swing business."

Drayton also is somewhat jaded by the HomeGrocer.com experience. Although venture capital firms such as Madrona and Kleiner Perkins Caufield & Byers provided value to the business, Drayton said there is "still a bitter taste in our mouths for all of the things that happened."

Drayton said he would not rule out accepting venture capital again. And he has no problem showing his new companies to previous investors. But he also adds, "I don’t know if it is worth the brain damage.

"It is a significant amount of work to properly manage your venture investors."

Bill Sornsin, a former executive at Rivals.com, a Seattle online sports company that burned through $75 million in the late 1990s, said venture capital wasn’t really an option when he co-founded TheInsiders.com in August 2000. That’s because venture capitalists were spending nearly all of their time repairing portfolio companies. So instead of wasting energy on massive fund-raising efforts, Sornsin, along with partner Jim Heckman, focused on profits, short-term results and a modest business proposal. The Seattle company, which employs 25 people, raised less than $5 million from angel investors. It has no plans to seek venture capital financing.

"In our case, as with a lot of other start-ups, we have set our aspirations a little lower, a little more reasonable," Sornsin said. "We are in the business of growing a company rather than of trying to get big fast. We didn’t need as much money, and VCs have a minimum hurdle." He also said the founders didn’t want to give up too much control.

Forfeiting ownership of a start-up company not only can cause internal strife, but it also can be incredibly costly.

Entrepreneurs are having to give up a greater percentage of their companies in order to secure venture capital. A recent study by VentureOne found that venture capitalists were taking a 49 percent ownership stake in the first financing round. That compares with 39 percent in 1998 and 42 percent in 1993.

"New enterprises are being started, but they are not looking to venture capital like they used to," said John Gabbert, vice president of research at VentureOne. "For the serial entrepreneur, who knows they can do it, it doesn’t make sense for them to give up that much of the company." The difficult terms facing entrepreneurs are one of the reasons why venture capital activity has slowed, according to Gabbert.

Hickman, who has built SharedInk with small business loans, personal savings and home equity financing, knew he didn’t want venture capital based on his past experiences. When Viathan was merged into a competing company in 2001, Hickman received only $492 for his 1.7 million shares.

In the contract with the venture capital firms, Hickman agreed to what is known as a liquidation preference. Common in most venture capital deals, these agreements guarantee a return for the VCs if an acquisition occurs. In other words, they get paid before anyone else and usually at much higher rates of return.

A venture capitalist who invests $10 million into a start-up company can negotiate a liquidation preference that calls for a return of at least three times the initial investment. If the company is acquired for $30 million, the VC would receive all of the money. Common shareholders — including employees and founders — would be left with nothing.

With capital harder to come by in recent years, some venture capitalists have squeezed entrepreneurs with more stringent liquidation preferences. That has led many small business owners to "bootstrap" their enterprises or turn to friends and family members for money.

"I have heard of people where liquidation preferences are set at two times or three times (the investment)," Hickman said. "You are basically selling your soul at that point because your back is up against the wall."

Hickman doesn’t fault VCs for trying to get the best deal possible. And he does think there are businesses that can benefit from venture capital. But SharedInk isn’t one of them.

"I have done it the really slow way, because I have done it my way and on very limited capital," he said. "But it is very gratifying and satisfying."

Venture capitalists will be the first to say that their money is not meant for everybody. At a recent breakfast meeting in downtown Seattle, that point was stressed repeatedly.

"Venture capital is the worst sort of capital. It is very expensive, and people really want to get involved," said Madrona’s Matt McIlwain. "Hold out as long as you can."

Chad Waite of OVP Venture Partners issued a similar warning to the crowd of entrepreneurs.

"If you are raising venture capital, you better realize at the beginning that you have no control," Waite said. "You have to make the mental leap that it is now ‘our’ business."

Some entrepreneurs — who have been through the start-up process before — don’t want to make that leap.

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