George Grellas has been practicing business law in Cupertino since 1984. He made some very insightful observations about formation issues at our February 16th Bootstrappers Breakfast we reported in “George Grellas on Why Startups May Benefit From Incorporating Earlier Than Small Businesses.”
George has worked with thousands of entrepreneurs in helping them with their strategic planning, entity formation, IP protection, funding, acquisitions, and the whole range of their startup legal needs involving both deals and disputes. He is a clear and insightful as a writer as well and in addition to authoring the Startup Law 101 Series of tutorials for founders and entrepreneurs he also writes very well thought out essays on the Hacker News site.
In a recent post he addressed a point about considering investment options based on the bona fide needs of your business. When folks at a breakfast ask “how do I raise investment” one of the common answers is do you have a business that merits investment, and what type of investment. What follows is a great essay by George Grellas on this point that he originally posted on Hacker News at http://news.ycombinator.com/item?id=1613249. It is posted here with his permission, and hyperlinks have been added to provide references for some of his points.
Successful startups can come in many shapes and sizes, though some highly respected people like Steve Blank take the view that what you are building cannot legitimately be called a startup unless it shoots for the moon and seeks to massively scale. I think that Mr. Blank’s view reflects VC thinking, and it is a legitimate point of view from that perspective. All small-scale businesses, in that view, are and will always remain “small businesses” unless they aim for massive growth and for a transformative commercial outcome, in which case they are true startups.
High risk. High reward. High failure rate.
But, in this view, you are not doing a true startup unless that is the view in mind. Of course, any such startup will necessarily require large infusions of capital in order to aim that high, and this assumes it will be VC-funded.
I strongly disagree with this VC-only view of startups (that is, with its being the only legitimate form of startup), and the founders I have worked with for years have tended to reject it as a working approach to their startups. These sorts of founders have always valued the independence of keeping control of their ventures and of seeking to build it to the optimum level for their needs and then either selling it or keeping it as a longer-term business that is solidly profitable.
Even in the days when it took far more capital than it does today to launch the prototypical Silicon Valley startup, it is amazing how many such independent startups managed to thrive and flourish in the nooks and crannies of the startup world. The founders behind such companies had all the exceptional qualities that solid entrepreneurs need in order to conceive winning ideas and to execute them well.
In today’s environment, such independent startups are thriving and flourishing all the more as the capital needs for launching a startup have sharply declined. The independence of the entrepreneur, and the corresponding power of control over one’s own company, is stronger than ever. This is solidly confirmed today in Silicon Valley and elsewhere as early-stage startups are proliferating while VC-backed ventures have been comparatively stagnant. In this sense, it is perhaps a new era for startups. Those that want to build their company independently, or even those who ultimately plan to seek significant outside funding but wish to defer such funding until they can build solid value and minimize dilution, are in the ascendancy and this trend is possibly a permanent one.
All that said, the founders who fit in this “independent” category have never, in my experience, seen investors as the enemy. There is an antipathy to VCs who propose shark-like terms but never to quality VCs who can legitimately take the company to the next level. Maybe they don’t want to take the risks associated with such a course, but the founders see it as one legitimate option to consider – to consider and reject for many of them, perhaps, but to consider nonetheless. They are not harmed by the presence of such VCs but rather helped in that their choices are broadened for situations where such a path might become attractive to them.
Whatever may be said of VCs, though, there has never been any general antipathy to angels as a potential investment source. Angel investors have always come in all varieties. Many are successful entrepreneurs in their own right and they not only can invest money into a promising venture but also other talent and expertise that can help guide the venture. I have seen such situations firsthand, over and over again, where such contributions have proven invaluable to the startups involved and much appreciated by the founders. It is precisely by this means that founders often can raise the comparatively modest amounts of capital that would be too much for the founders themselves to risk but that are essential to building the venture to the point where it can become commercially feasible. Such companies have nowhere to go without such capital, and the angels are there to supply it on terms that are often reasonable and very much in the interests of not only the angels but of the founders also. To categorically write off this sort of investment as coming from some congenitally hostile source that must be resisted at all costs by founders is a mistake. Some ventures, of course, will want strictly to self-fund. But not all do. Indeed, from my experience with having worked with countless founders, I would say that most do not want to limit themselves strictly to self-funding because they themselves see that pure self-funding will not enable them to realize their goals for their venture.
I am not saying that all angel investments are good or that all angel investors are benign. It is a shark’s world out there and, whenever entrepreneurs are taking investment money, they need to watch their backs. But to dismiss angels as a category is to dismiss the idea that founders should have a broad range of choices before them in seeking to build their companies, and such a categorical dismissal is a serious mistake for most ventures. It is like saying that, because there are risks in a certain direction, I as an entrepreneur will never walk that path even while my competitors keep that option open for themselves and perhaps use it to outrun my venture through needed capital infusions that can often take a company to a better level.
My advice to founders: don’t be gullible in allowing yourselves to be cowed into taking in investment money for no good purpose other than to brag about being a legitimate startup; but don’t become so narrow-minded about investment options that you box yourselves into a strictly self-funded venture in cases where that may not be in your startup’s best interests.
In other words, forget categorical rules in this area. Consider angels and their investments in light of the bona fide needs of your venture and, if they can meet those needs, then by all means avail yourselves of the value they offer (and, yes, do it on the best terms you can and watch out for the vultures). If they don’t meet your needs, and you see more value in building a long-term profitable company without looking to be acquired, then by all means avoid investments that will only complicate your company and your life.
But by all means keep a balanced view of this or you will only arbitrarily limit your own legitimate options for building a successful venture.