Jacques Mattheij

Technology, Coding and Business

If Growth By Itself Was Good Then Getting Cancer Would be Good News

Disclaimer: the cancer analogy is in no way meant to cause mental grief to anybody, I’ve lost enough family members to it that I realise such an analogy may be a step too far for some, but I feel that in this case its use is justified. If you do feel offended by this in any way then my apologies.

One of my favorite VC bloggers wrote an article that I’m pretty sure was meant to be serious but that had me in stitches. Fred Wilson, famous in VC circles and a very smart guy wrote an article that contains a whole series of gems, the best one of which was this line:

“At some point you have to build a real business, generate real profits, sustain the company without the largess of investor’s capital, and start producing value the old fashioned way. “

The reason why I thought this was supremely funny is that if VCs start to complain that their start-ups are not behaving like bootstrappers it’s like hearing an SUV driver complain about their mileage. Who bought the thing in the first place? Who gave this money to be used as fuel to a company without a profitable model in the first place? Who thought it was a good idea to buy a vehicle that requires so much fuel that using it to haul a product you sold from ‘a’ to ‘b’ means you lose all your margin on the fuel bill?

VCs tend to get their return from a relatively small number of investments out of a much larger portfolio. The earlier stage they invest, the larger that portfolio has to be. In order to maximize the returns the typical VC funded start-up will do everything to substitute capital where you’d normally expend time. All this to chase the one number that they are all interested in, which is growth.

That would be all find and dandy by me, if it wasn’t that growth per se is not a good thing. Organic growth is a good thing, it’s healthy, it gives you time to maintain your corporate culture and it makes sure your company does not get away from you, or ends up crashing spectacularly. In biology, uncontrolled growth is called cancer, and it’s arrival is not generally heralded as a good thing. Cancer needs fuel, and in order to get at it it will rob healthy tissue of the supply lines that it needs to fuel its rampant growth. Until the organism no longer knows how to deal with these ever increasing demands on its various systems and succumbs because critical organs no longer get what they need.

Rewind to the summer of 1998. Camarades.com had launched in March and was doing very well. We were growing fast but not too fast (though ordering servers timely was a tough balancing act), we had a relatively solid ad fueled model and we did not need much in terms of capital to keep this up. It wasn’t a huge business but it was doubling in size roughly every month from an income point of view and we managed to keep our payroll limited and our other expenses in check. Not a cent was spent on marketing, all our referals were organic, people simply liked the product.

Roughly at this time we were approached by an American based company called ‘spotlife’ for a potential technology buy-out. Now spotlife was from a tech point of view doing a poor job, but they had two things that we could not easily match: $30M in the bank from a combined investment from Philips and Logitech, and on top of that access to Silicon Valleys finest. The price-point of their product was set so low that it made me wonder if they had been to the ‘Minderbinder school of business’:

“We lose money on every transaction, but we’ll make it up in volume”

In the words of their CEO (some MBA guy): “You and I are on a collission course, and we have just thrown away the steering wheel, who do you think is going to flinch”.

Famous last words, we didn’t flinch and refused the offer. Spotlife went down in flames less than two years later, having burned through the larger part of that $30M as if it was toilet paper. Fancy offices, subsidized product, huge staff, over-hyped launches, underwhelming product, you name it they had it.

So, spotlife practically killed the market for us. And they were behaving just like the start-ups that Fred Wilson is lamenting about. They spent their money to do a classical ‘landgrab’, but they forgot that you also have to hold the territory that you grab and that at some point your VC capital will run out and then you had better be able to make ends meet.

And this is where I think quite a few start-ups get it wrong. They’re inspired by the likes of YouTube and Instagram and see nothing but growth.

But in the end, for founders rather than investors there are more ways than one to the finish line and besides the fact that such fast growing companies without a clear path to profitability can spoil an entire segment (once users have gotten the product for free from your soon-to-be-bust competitor I wish you good luck in trying to charge for it) is bad for everybody in the long run. For VCs (especially earlier stage) there is only one important factor: they need a few ‘out of the ballpark’ successes to make up for the the losses on the rest of the portfolio. So their goals and founders goals are rarely aligned in this respect.

These companies are in a race to be acquired or to find a model before their precious capital runs out are spoiling the soup. And woe to the founders if they miss that window, that ‘B’ or ‘C’ round could easily result in them losing the ability to call the shots in their own house.

I suspect - but have absolutely no proof - that if you would take the total sum of the valuation of all VC backed companies that came out of SV in the last decade or so and you divided that by the total number of founders that went in and did the same for the ‘bootstrappers’ that the bootstrappers on average did better. None of them (or at least, not many of them) will be billionaires. But they’re going to have to do exactly those things that Fred Wilson wants his companies to do: concentrate on revenues and profitability rather than on growth for growth’s sake. So they’ll be building profitable companies which will then be called (derisively) ‘life style’ companies rather than ‘real companies’. As if a company with say 25 employees and $10M turnover is a bad thing or a hobby. The Go-big-or-go-home attitude runs deep and I’m perfectly ok with people attempting to do this (see three roads to the top of the mountain) but I don’t understand why simply running a good old conservative business with a substantial chance of long term survival is a bad thing. Not everybody has to play the lottery.

The silver lining on the cloud is that once these burn-baby-burning competitors go under that you usually can pick up their assets for a song once they go bust (Aeron chairs at $0.05 on the dollar are a good deal). But once you’ve fine-tuned your business model and you are ready to roll out internationally and you really need that Venture Capital (which is supposed to be used as an accelerator, not as life-support) then you will find that your locust competitors have left the field barren. That segment is now poisoned and you’ll have to slog it out on your own unless you get very lucky.

Surviving the intermediate period while they still have capital and are spoiling your niche with freebies that you can’t match is going to be a long and hard exercise in frugality and teamwork. Hang on to your core team during that phase at any price, do not under any circumstances try to imitate them at their game, that will reduce your chances of survival even further!

VCs should be far far more critical about the companies that they invest in, that the path to break even is clear and that they are not going to invest in a company whose business model is broken but where the cracks are paved over with marketing and growth by burning investors money. Especially companies where investment is made in B, C or even later rounds should be looked at very carefully. A healthy company would survive and grow even without VC investment. If it can’t do that then it probably is better to not invest at all rather than to have to write angry blog posts later.

HN Submission/Discussion
If you read this far you should probably follow me on twitter: