Venture capital versus self-generated funds

An article in Re|code, “The rise of giant consumer startups that said no to investor money”, looks at the rise of companies that have managed to grow without resorting to rounds of external financing or venture capital and the associated advantages. The piece is illustrated with a number of successful consumer products companies recently bought by industry giants, such as MVMT (owned by Movado since August 17), Native (acquired by P&G in November 2017) or Tuft & Needle (fusion already announced with Serta Simmons).

The advantages of growth through self-generated funds, or bootstrapping, are clear and obvious: the founding team enjoys full independence to make decisions throughout the life of the company, has greater freedom to stick to its long-term objectives, is not distracted by power struggles over ownership, and above all, it turns survival into a test of its business model.

That said, the drawbacks are equally evident: in many cases, the founding team’s independence means it can make bigger mistakes because unlike with external financing, it has no access to experienced professional managers to oversee decisions. This is evident when a venture capital company has a vision and is willing to contribute more than funds, although it can also simply do what all venture capitalist do: exit with return that meets its objectives, which in some cases can derail the founders’ long-term vision or objectives. Not having to deal with struggles around ownership can also be an advantage, but only on the occasions when it really is: at others, tensions within the own founding team over individual decisions can become a major distraction, and at times become personal. Let’s not forget that venture capital investors assume part of the risk, with all that that entails.

Companies financed with self-generated funds are usually seen as “less sexy”: growth tends to be slower, exposure to media is usually lower (news related to their funding rounds tend to form an important part of the media noise generated by many startups), and this can an impact talent recruitment and retention. These companies are usually subject to a certain austerity, with low pay and few bonuses the order of the day until growth objectives have been met or a hypothetical acquisition carried out. On the other hand, the need to maintain extreme vigilance over the use of funds usually means attention to optimizing the most important aspects of the business, compared to companies where problems can be solved by convincing some shareholders to participate in another round. It is often said that growth through funds generated by operations allows companies to focus entirely on the client instead of investors, and that this tends to increase the chances of building a viable business. From the customer’s perspective, it sees founders who are real people, not a large, abstract organization.

In practice, companies tend not to have much choice as to whether they finance through venture capital or self-generated funds: they do so based on the alternatives available to them at any given time. There are guidelines for risk capital: it calls the shots, and to obtain typically requires skills, knowledge and contacts not available to most people. Self-generated growth means the books have to balance, which tends only to happen when financing needs are not very ambitious or high and in addition, the company is reasonably profitable. As Re|code’s piece implies, this is more usual in the case of consumer goods companies, where selling directly can absorb profits and the using large distribution channels can require an investment beyond the reach of the company. Ambitious startups that hope to change the world are not likely to do so with their own money, requiring not just external investors, but patient ones.

In the final analysis, for every success story, whether self-financed or based on outside investment, there are a hundred failures that nobody reads about. When a company is finally sold, the role of the founding team can be enormously important: on the one hand, their presence in a company they have signed over is usually essential in that second phase of growth under new ownership. On the other, the fact that the founders have retained part of the ownership by avoiding external financing means that they have a personal stake and may disagree with the policies of the new owner; equally, they may be assigned manager roles, reducing their level of commitment as they see a chapter in their life closing.

Anybody thinking of starting a company should think long and hard about the different financing variables and how they might impact the future of the project.

(En espa?ol, aquí)

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