What To Do When There’s No Venture Capital

It’s agreed. We’re in the biggest economic downturn we’ve ever seen. So why would anyone want to launch a startup?

1937 photo by Dorothea Lange

1937 photo by Dorothea Lange

Maybe because a downturn is the best time to launch a startup (see “6 Reasons Why This Economy Is Good For Startups”). Or maybe, “Why not?”, because what else are you doing that’s truly worthwhile? Or maybe, finally, because startups are the only way to create prosperity when established businesses are failing.

Whatever your motivation to launch, some of the rules for success just changed (along with everything else that got broken with the collapse of 2008).

The End of the Road for the Silicon Valley Success Story?

For the last twenty years, the technology business has been dominated by one success model: start with a clever idea, put together a stellar team, pitch the venture capitalists and get their funding, build and launch, and exit with an IPO or an acquisition. The model has evolved over the years. You could put together a team by offering equity, with little cash required, but after the dot-bomb days were over, skilled programmers started demanding cash instead of equity. The role of angel investors increased over the years, so now most startups look for angel investors before they look for VC funding. The importance of building prototypes (as opposed to going straight to build and launch), as well as expectations for customer acquisition before funding, have also changed over the years. But in late 2008 the whole picture changed.

Silicon Valley got its wake-up call in October 2008 when the eminent VC firm Sequoia Capital presented its R.I.P. Good Times slideshow (brought to the public by TechCrunch and VentureBeat). Their message? If you’re a startup, slash spending, lower risk, reduce debt, and get “cash-flow positive” because money from VCs is going to be tight. And don’t expect to exit with an IPO or acquisition in the forseeable future. Sequoia Capital didn’t mention it, but even more challenging are questions about the viability of venture capital firms in the new economy. Given the poor performance of venture investing in the last seven years (returns of only 0.2 percent), and a shortage of money among the investor class, VC firms may no longer be driving the bus for everyone looking for high-technology success (see Venture Capital at a Crossroads from an enterprising San Diego reporter). Paul Graham of Y Combinator wrote at length about this (December 2008) in his essay Could VC be a Casualty of the Recession?.

What Happens Now?

If you’re planning a startup and you expect to get venture capital, make yourself a note. It’s time to rethink your plan. You might get VC money someday. But it’d be a good idea to consider how to launch and grow your business with a smaller investment.

Fortunately there’s good news. The reality is that VC-less bootstrapping is now possible.

The cost of development has declined considerably in the last five years. What used to cost $1.5 million can now be done for $150 thousand. And the $150,000 project can now be built for as little as $15,000. That’s a difference of an order of magnitude. It’s one of the reasons angel investors have gained importance in the last five years; often, an investment of $50,000 to $200,000 (typical from angel investors) is enough to develop and launch an online business. It also makes it possible for a business to launch with $10,000 to $50,000 of “friends and family” money, given a narrow and highly focused scope and, most important, a very efficient and productive development process.

Here’s more good news. If you can launch your business with less than $50,000 of seed money, you have a good chance of success in the new economy. One reason is paramount: You’ll be building a lean company and you’ll have to focus on customer acquisition and revenue growth far earlier in the game than most web-era technology startups. Without the deep pockets of a VC firm, your value proposition will have to obvious and you’ll have to execute without error. There will be no “do-overs,” with either your business model or your development effort.

Getting Expert Help

There’s a problem, though. You’re losing more than a funding source when you try to build a business without a VC firm. You won’t have access to the guidance of seasoned entrepreneurs and technologists. You’ll have to find people who are facing the same problems as you. It’s important to get to know other web entrepreneurs (online and face-to-face). You should also talk to angel investors, but in doing so, recognize that their advice may be more available than their checkbooks. Get networked, online and off. And listen carefully when you’re offered advice.

For technology advice and services, recognize that you can get help from consultants and part-timers. See my blog post, Startup Advice: When to Use a Consulting CTO. Increasingly, people who were only available as full-time, equity-position founders or stock-option employees are available on a part-time basis.

Again, it’s important to avoid costly mistakes. Arguably, technology mistakes are your biggest source of risk with a new startup. They may be the most expensive mistakes you can make. And they will cost you precious time and opportunity. Recognize that most business-side entrepreneurs are unprepared to make technology decisions (is that true for you?). Be careful who you rely on to help you with these decisions. Now’s not the time to place the future of your business on a guess or blind trust. That’s why it’s a good idea to bring in outside expertise.

Your Development Process Is Key

There are two kinds of expertise you’ll be looking for. One is help with technology choices (“implementation choices”). This will include your web application framework (Ruby on Rails, PHP, Microsoft .NET, etc.) and architectural choices (cloud computing, web services, etc.). More important is the guidance you’ll need in defining your development process.

I’ll take a stand on this. Your success as a startup in the new economy depends absolutely on the efficiency of your development process. Development is the most costly and error-prone aspect of the startup game. You’re not going to have money to make mistakes. The only way to maximize the likelihood of success is to get help planning each step of your process so you execute efficiently. You’ll maximize your chances for success if you use a methodology that has been tested and proven successful.

Key Decisions

Here are some of the decisions that you (or your CTO) will have to make about your development process. Experience in making these choices, and drawing conclusions from the results, is what it takes to develop a methodology for launching startups.

  • How will you define the scope and functionality of your application?
  • Will you produce a requirements specification? Use cases? User stories?
  • Will you produce a wireframe or mockup?
  • Will you produce a prototype?
  • Will you demonstrate a proof-of-concept to investors or stakeholders?
  • Will you use an Interaction Designer?
  • Will you do user experience testing? At what stage?
  • When will you engage a graphic designer? And for what?
  • What software development practices will you use? Adaptive (“agile”) or predictive (“plan-driven”)?
  • What role will testing play in the development process?
  • Will you need a lead developer, director of engineering, and CTO? Which? When?
  • Can you send development offshore?
  • Can you run any development processes in parallel?
  • How will you prepare for problems of scale?
  • What will be your release milestones and how will stakeholders participate?
  • What are the stages of development and what dependencies are in play at each stage?

All these decisions are critical elements of the development process. And each is critical to your ability to execute efficiently and launch with minimal capital.

There’s Bad News

In my experience, most business-side entrepreneurs don’t have the expertise to make these decisions and often don’t understand why they matter. That’s not surprising because much of the required knowledge is part of the arcane lore of software engineering or project management.

Unfortunately, I’ve also discovered that many technologists are not qualified to make these decisions, either. They may recognize some of the elements of effective process (for example, “agile” versus “waterfall” software development practices) but often make decisions based on what they’ve done before, without evaulating whether it worked well or not, or even if there is another way to do it. They may not know where a process is most likely to fail and what the best choices are for a web startup. This is why the “art of the startup” requires special expertise. And this is why so many startups spend more money than they should. And spending too much money? That translates to “fail” in the new economy.

But Help Is Here

To increase your chances of success, I’m going to focus on the most important elements of the development process in future blog articles.

UPDATE (August 12, 2009)

Fred Destin, one of the most articulate VCs in Europe, writes about The Funding Drought (and its consequences) in a blog article.

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4 Responses to What To Do When There’s No Venture Capital

  1. Great Article and explanation of what’s going on right now. I totally agree with you that even though the current situation these might be a good moment for start ups to start being more focused and committed to succeed.

    Some years before a good idea was almost enough to raise some money so the challenge wasn’t pushing enough CEO & CTO to work as hard as they could have.

    Now challenges are higher and only those who really want to make it happen will be able to shine.

    Keep it up with this great job that you are doing!!

    Daniel Romano.

  2. Sophia says:

    Hi, thank you for the articles, they’ve been very helpful. I’m currently starting a project with a CTO, and am trying to do research on compensation. My guess is that I won’t be able to afford to pay in cash (the website will be pretty extensive), but I’m having a hard time finding good info no how to structure an equity partnership. Can you recommend any resources?

    Thank you!

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