Funding a Startup Without VC
April 18, 2011
I love entrepreneurship, and I love tech startups, but sometimes I'm struck by the lack of perspective that many tech entrepreneurs have about creating a startup. One of the most common things that entrepreneurs in the tech sector lose sight of is that most companies never get venture capital funding, especially outside of the technology world. That's not to say that VC hasn't played an important rule in the growth of many of the biggest and best companies, sites and apps. It's just not the only option.
There's also been a change in the economics of building a web-scale business; As I outlined in my piece about mom and pop startups at web scale, the hard costs of growing a business built on a website or app have come down enough to allow for bootstrapping or alternate funding as a realistic path to growth. And of course, many entrepreneurs have always had concerns about the lack of ownership and control that's inherent to accepting funding from traditional VCs.
If getting venture capital is now optional for making a big, successful business, and lots of entrepreneurs might want to avoid it anyway, what are the other options? I've outlined a few other common options, including examples of companies that have made these options work, and some of the cons of each method that might explain why don't we hear about them as much as we hear about venture capital.
This isn't saying VC is always a bad thing. I've helped friends get funding from venture capital firms, and worked at a company that was VC-backed. But by understanding and pursuing these options, even entrepreneurs that choose to get venture funding can strengthen their businesses and their negotiating position when it comes time to talk to VCs. And some will find these options obviate the need for VC at all.
Friends & Family
- Pros: Builds your support network; taps into resources you're already connected to
- Cons: Can cause personal stress; personal network might not connect you to new opportunities or resources
Good old-fashioned friends-and-family funding! Almost every entrepreneur uses this sort of funding at the earliest stages of their work, and it's often been the only funding for traditional physical businesses like restaurants and small retail shops, especially in immigrant communities.
The limits, of course, are that your friends and family have limited finances, and it can make for an awful awkward Thanksgiving if your business isn't going well.
Examples: Almost every startup you've ever heard of began with a friends-and-family round of funding. Most moved on to other methods later, though.
- Pros: More people are starting to understand this model; You build an enthusiastic customer base right from the start of your company
- Cons: It doesn't always work; You might not be able to duplicate this sort of funding success if you want to grow later
There's a lot of attention on sites like Kickstarter these days, but much of it focuses on the outsized success stories of a few unusual cases. Much more interesting are the smaller efforts that seem directly analogous to the friends-and-family funding that entrepreneurs have used for centuries. While Kickstarter is more oriented to artistic, expressive projects, Profounder lets people focus more explicitly on business. Either one's a good choice if you want a path that will require you to clarify your marketing message and product story right from the start.
Examples: Just browse around Kickstarter and Profounder, there's a whole bunch of them.
- Pros: A familiar, known way of funding small business; relatively low returns desired compared to VCs
- Cons: Banks aren't very good at high-risk ventures; Very few loan officers are tech-savvy enough to evaluate a tech startup
This is a tricky one — banks generally look for a more sure bet when making loans. But if you are optimizing your startup for deliberate, steady growth, this might be a great option. I don't have great examples of where this has worked, but I'm sure one of you does?
- Pros: Really easy to get; Maybe you can earn a free plane ticket; Your Visa card only wants a 30% return instead of a 300% return
- Cons: You can destroy your credit; Most people inexplicably feel more stressed out owing money to credit card companies than to VCs
Google's cofounders bought their first 120 hard drives by using "all of our credit cards and our friend’s credit cards and our parents’ credit cards". Charles Huang of
Harmonix took it even further, getting a second mortgage on his house. Not what I'd recommend, but hey, these folks made it work. [Apologies to Charles, and to the Harmonix team, for originally getting this wrong.]
- Pros: Lowers your startup risk; A good fit if you have personal obligations that make quitting your job difficult
- Cons: Can be a distraction to manage the old business; Requires immense discipline to pull off
What if you take the advice "Don't quit your day job!" as a compliment instead of an insult? Lots of folks do this to good effect — I always phrase it as "Don't let your job get in the way of your career." You can bootstrap a new effort while hanging on to your current gig (and your current healthcare) and maybe reach enough size to be able to quit your job later. Two of my good friends have done this: Matt Haughey turned MetaFilter into a sizable, valuable website while working other jobs during the day for the first 6 years of the site's growth. And Jason Kottke has launched Stellar alongside his day job of publishing Kottke.org, though being his own boss means he'll never have to quit the latter for the former.
Examples: Stellar, MetaFilter
From Services to Products
- Pros: Often have great talent already recruited; Leverages the awareness and business infrastructure you've already built; Lowers your risk
- Cons: Hard to fire your old customers if it's required when the new business takes off; Few companies succeed with the transition of skills required; Easy to put off hard choices if the old business is stable
Almost every web design or app development firm I've ever talked to has had plans, at least at a vague level, of creating a product using their in-house team of developers and designers. Most never get off the drawing board, and many end up as internal-only products, used to better serve customers. But ever since 37Signals defined this potential for the Web 2.0 era with their success in building apps (and their success in talking about their success in building apps), it's a dream that's actually worked for some companies. The hard part is really deciding to rip the band-aid off when it's time to leave the service business behind.
Examples: 37Signals, MLKSHK, Coudal Partners, MeasureMap, Readability
Non-Profits and Grants
- Pros: Can sustain much different business plans; Often very little entrepreneurial competition for dollars; Makes it easier to align product goals with lifestyle goals
- Cons: Sometimes limits on business structure or business model; Participating in grant programs and funding can be onerous or tedious; Socially-oriented funders can be risk-averse
Very few people remember that Ludicorp, the company that created Flickr and sold it to Yahoo, had one of its earliest infusions of cash thanks to a grant from the government of Canada. If you don't have the good (?!) fortune to be Canadian, there's still an extraordinary amount of resources available for entrepreneurial efforts — they just might have to be done within a non-profit corporation. (I'm also a big fan of limited-profit corporations, though I don't know of any startups structured that way, yet.) As you might guess, Expert Labs runs like this; Though we're part of AAAS, significant funding for our efforts come from the MacArthur Foundation. Other startups that are similar to us, like Code for America get also funded by groups like the Knight, Case, Omidyar and Ford Foundations. Now granted, being a non-profit means you probably won't have a bunch of equity shares with a potential payday. But that's true for most startups, too.
Examples: Ludicorp/Flickr, Everyblock, Expert Labs, Code For America
Old-Fashioned Sales or Advertising
- Pros: Keeps you aligned to what your customers want; Builds you into a sustainable business; Introduces rigor into your business model right from the start
- Cons: Optimizing for revenues up front can limit the speed that your company grows at; Learning to sell and support advertising can be a distraction from the core product; You can't evolve past parts of your product that you're charging for
This part's no surprise: You can just sell stuff and make money in order to grow your business. What's often overlooked is that some of the biggest, most-established web-scale companies did exactly this. If your overhead is low enough and you've got something people want from day one, this is a great way to go. Lots of folks think of Craigslist in this category, but few consider what Plentyoffish did in using ads to grow to enormous scale as well.
Examples: Craigslist, Plentyoffish
Show Me The &c.
To be clear, this list is neither exhaustive nor detailed enough to fully explain these options. But so many companies choose these options, especially in the earliest stages of starting up, that it's bizarre there isn't more conversation about these funding options as the default choices for new companies. Picking one or more of these paths as the primary, or even sole funding options for a company doesn't mean that you're limiting yourself to a small-time operation.
In fact, knowing these options only increases the chances that you'll find a funding opportunity that's a good fit for the organization, product, and community that you'd like to build. Making good use of these resources means you'll be in a stronger position if you do choose to pursue venture capital. And understanding the potential of these options might just give you a different perspective on what your goals are as an entrepreneur, and what it really means to be an entrepreneur than the VC-focused narrative that so much of tech media focuses on.
If you've got other success stories, or even other warnings, about companies that have used these techniques, please do let me know. And if I've missed some options ("Let's have a bake sale!"), let me know in the comments, too.