The Good News, Linux Fans, is Venture Capital Is Harder to Find

"With so much turmoil today, the good news is that there are more areas of opportunity for new products and services than ever. The even better news is that most of these opportunities won't attract venture capital."

Andy Updegrove writes the excellent Consortium Info Standards Blog, so he should be familiar to anyone who followed the SCO follies on Groklaw. I like Andy's writings for a number of reasons: one, he IS a lawyer, and not some typical IANAL Slashdot reject who confuses baseless opinion with knowledge, and two, he is a lawyer who dares to make the occasional definitive statement, and even (No really! you can see for yourself) makes sense to the normal, intelligent, not-a-lawyer reader.

Andy's current blog entry is on a subject near and dear to my heart. His title is a typical plain, descriptive title: Raising Venture Capital and Other Risk Factors. I keep telling him to tart up his titles, to learn how from some of the more shrill, click-happy tech sites: Ten Reasons Vulture Capitalists Suck! Eight Ways to Get Fleeced! Fifty Ways to Have Your Dreams Ripped From Your Very Heart! But even without snazzy titles his blog is well worth reading, because he shares from a career-full of practical experience:

"Here in New England, where I practice law and have been representing startups for thirty years, we have a mixed blessing. On the plus side, we have great universities, like MIT and Harvard, with professors and students that come up with great inventions that new companies can be formed to commercialize. We also have lots of folks that have done it before, that can act as mentors and role models...

"On the negative side, we've got a lot of venture capital firms that call the Route 128 area home."

That's a negative? How can that be? Is it not the dream of every starry-eyed geek to launch a tech startup, acquire venture capital funding, and get rich fast? It's darn near heretical to speak against this seductive vision.

Netscape Launches the Gold Rush

The Netscape IPO (initial public offering) way back in 1995 launched the tech venture capital goldrush. It was a fluke event, but humans are funny little critters, even tech geeks who think they are smarter than the average person, and they sure weren't any smarter when it came to business. Here was this startup co-founded in 1994 by Marc Andreessen, a pudgy little nerdguy that hardly anyone had ever heard of. (A smart man and a good person, too.) Then in 1995 Netscape went public at an initial offering of $28 per share, and the frenzy was such that it peaked on opening day at $75, and overnight Mr. Andreessen and his co-founder Jim Clark were millionaires.

Well that was enough to stoke the greed-fires for the slavering masses, and thus began the tech gold rush. Everyone who could string a few lines of C code together wanted to be an entrepeneur, but not the kind that built a solid company that they actually intended to run, and to make good products and respectable profits. No, the goal was to get venture capital funding, live lavishly, go to an IPO as quickly as possible, cash out and move on to the next big strike. Running an actual business and acquiring and retaining actual customers were incidental and unimportant parts of the plan.

A Funny Thing Happened on the Way to the Ferrari

The flaw in this beautiful scheme was the venture capitalists themselves. Andy Updegrove explains:

"But the money comes with a number of catches. One is the expectation that you'll step aside if you're not succeeding. Another is that when your company is sold, the investors will get their money back -- and often much more -- before you receive a cent. Worst of all, because VC investors want to hit a home run, in normal times they expect you to spend every round as if it won't be your last. But if your product doesn't sell well enough, it just may be. When that happens, there’s usually no choice but to sell the company at a loss, or simply shut the doors.

"This sort of model works well for VCs, because each invests in dozens of companies, with the home runs making up for the wash outs. But an entrepreneur's portfolio includes only one company -- and odds that are stacked against her."

One thing that Mr. Updegrove does not mention is the VC management fees. Way back just before the turn of the century I had a boss who wanted to be a Player, a Mogul, the Go-To Guy. So he got cozy with this venture capital firm, let's call them Moneybags, Inc., who had a real nifty setup. They did not invest their own money, for that would be scary and risky. Instead they courted investors and put their money into a single fund that was used to finance several startups. Moneybags, Inc. then worked with the startups in the traditional venture capitalist fashion. I attended a number of presentations to potential investors, and even though I knew what was coming every time, it still gave me a jolt when they got to the part where they divulged that their management fee was 20% off the top, plus participation in the profits. So the investors were 20% in the hole from the start.

Maybe this is a typical arrangement, I don't know. All I know is Moneybags, Inc. was guaranteed a fat payday no matter how badly they performed, while everyone else assumed all the risks.

So what's the ambitious entrepreneur to do? Mr. Updegrove advises

"In contrast, a founder that bootstraps, perhaps assisted by funding from family and friends, can be consistently more conservative, placing the highest priority on survival...Over the last twenty-odd years, my firm has represented close to 2,000 startups. When I check the score card, I see two things: the first is a lot of clients that have made millions -- sometimes many millions. The second is that the vast majority of the winners are those that bootstrapped."

I'm thinking that there is much wisdom in Mr. Updegrove's article, and that bootstrapping is especially suited to Linux and FOSS. FOSS lowers the barriers to entry to the point that merit, skill, and hard work are more important than fancy financial footwork.