Why venture capital is like a bad drug for startups

Why venture capital is like a bad drug for startups

I’m a big fan of bootstrapped companies. It’s a backwards thing to hear a professional investor say.

I like them in part because building things with minimal resources is harder than building them with large amounts of venture capital. So when you meet a successfully bootstrapped business you know the founders have been through a special kind of hell to get where they are.



Bootstrapped companies build scale then unlock cost savings for themselves and their customers as a result. iStock/skynesher


But that’s not the real magic. After all, we shouldn’t get bonus points for swimming across a river if there’s a perfectly good bridge nearby.

Before the rise of venture capital, people had to build businesses with the resources they and their families had available to them. When a large opportunity like a new factory or a major expansion presented itself they either funded the expansion with operating cash or turned to a bank or a bank-like partner and fund the expansion as debt.

That’s what Tuft & Needle did. When this direct-to-consumer mattress maker decided to expand, it turned to Bond Street for debt financing. (For the record, we’re not investors in Tuft & Needle but I am a big fan of what the company.)

When banks or investors consider an investment they focus on two key questions:

  • Will people want the product the company makes?
  • Can the company execute in a world where the thing they want to finance exists (e.g. at larger scale, with a new factory, with more employees, etc)?


What makes bootstrapped companies so great is they have, unlike a great many of their venture-backed counterparts, proven the first question. Platforms like Kickstarter help do this for some companies though those platforms carry their own unique risks.

This is why my partners and I don’t invest in successful crowdfunding campaigns until they develop a stable, direct distribution channel. It’s only at that point that a campaign proves itself to be a company. A number of great companies in our portfolio — we’ve invested more than $40 million in nearly 100 companies — followed this path, among them are Ministry of Supply, Hammerhead, Mizzen + Main and Ring.

We meet new companies making cool things every day, the kind of stuff you and I use in our everyday lives. We get the most excited about companies who have made products, sold them to customers and need capital to help make their products better. As Derek Sivers says in his book ” Anything You Want,” “For an idea to get big-big-big, it has to be useful. And being useful doesn’t need funding.”

The ‘heroin drip’ of venture capital

Dangerous companies are dependent on venture capital. It’s like a heroin drip. It’s incredibly easy to get into the habit of using venture capital to build a business that, without the capital, simply shouldn’t exist. Companies that shouldn’t exist are companies that make things that cost $10, sell them for $5 and use venture capital to make up the difference.

Some founders and investors make a lot of short-term money in those types of companies. They use venture investment to make products cheaper and build market share quickly. And it’s no surprise that those companies grow quickly. After all, who would say no to a freshly cooked dinner delivered in one hour for $2.99? I wish those companies well but have no interest in investing in them.

Those companies use venture capital to bridge the gap between the cost of delivering their product and the perceived value of the product by consumers. Instead of using the capital to invest in finding customers the hard way, they use venture capital as a subsidy in the hopes that their scale will drive down costs. They think they are Walmart. They believe that if they build scale they will be able to drive down the costs so that the $2.99 price point is profitable. Time and time again they are wrong.

But they have a more detrimental effect. These companies sell us things we’ve never had before. And they convince us their thing is worth $2.99. When they successfully push their competitors out of business and the venture capital dries up, they raise prices to cover the costs previously covered by the venture capital subsidy, consumers walk. The investors behind these businesses hope these companies are sold or go public before this happens. Sometimes it does. I’m not interested in making investments that require that kind of magic.

These companies build things people want and sell it at a price that’s too good to be true. They make it harder for everyone else, especially the bootstrapped companies because they train consumers to think a product should cost less than it costs to make.

I prefer to do everything I can to help companies build stable long-term businesses that sell things people want to buy at a profitable price they are willing to pay for it. I invest in them. I buy from them. It’s why I bought a mattress from Tuft & Needle. That’s why my home security camera is from Ring and my closet is filled with Ministry of Supply and Mizzen + Main.

These companies build scale then unlock cost savings for themselves and their customers as a result. Sometimes they raise venture capital to build new product lines, sometimes they raise debt to expand production, and sometimes they do neither.

Anyone can build a company that gives things to customers at a price less than it costs to deliver it. It’s a very interesting model which, until recently it seems, we referred to as a charity.

Zach Ware is the managing partner of VTF Capital, a seed investment firm based in Las Vegas and San Francisco that backs founders building the future of commerce. Follow him on Twitter, connect with him on LinkedIn, and check out his blog.

[San Francisco Business Times]

March 30, 2016 / by / in , , , , ,

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