Enough With The 37Signals Babble: Venture Capitalists Are Not Evil

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Jason Fried and David Heinemeier Hansson, the founders of online project management tools company 37Signals, are famous for advocating the view that online businesses should focus on becoming profitable and never, ever take venture capital.

In a talk at Stanford, 37Signals partner David Heinemeier Hansson called VC “evil.”

Here are some of the things that the 37Signals guys don’t understand, or claim to not understand, about VC:

  • Nobody said VC was for everyone! If you can start a successful, profitable business by bootstrapping, more power to you! I don’t know any smart VC who would disagree. The incredibly vast majority of businesses don’t get VC funded, and this is how it should be. VC is only made for a very specific type of company — companies that have the potential to provide at least a 100x return for their investors. For the economics of VC to work, most of the startups they back have to fail, because otherwise they’re not taking enough risk. But then again most businesses fail, VC funded or not, and that’s no argument against entrepreneurship.
  • Taking VC does not mean playing the “Google acquisition lottery.” Where I agree with the 37Signals guys is that plenty of entrepreneurs want to raise VC because they think it’s “just what you do”, when most of these businesses are not in fact made for VC. And the fact that there is too much money in venture capital means that too many of these businesses, unfortunately for everyone, do get funded. I also agree that there is too much emphasis on companies that get acquired, as opposed to companies that actually build big, innovative — and profitable — businesses. A company might take VCs because it’s praying for an acquisition and it wants to keep the lights on, but these are never the companies that really succeed. A company might take VC simply to expand its operations or finance working capital. And a company, yes, might take VC because they have a good product or technology but don’t have the will or the resources to focus on monetization right away.
  • Failing is OK. The 37Signals guys seem to think that VCs are running some kind of scam, because most of the companies they back fail. Everyone talks about the “hits,” but it doesn’t help a failing startup founder to know that another company funded by his VC was bought by Google. But here’s the thing: failing is OK. I would submit that a founder who starts a company, raises VC, leaves it all out on the field, and fails, has learned more, is more employable, and more likely to succeed, than someone who hasn’t. They say that someone who starts a venture-backed startup and fails ends up with “nothing,” but that’s just not true. They end up with skills, relationships and insights that others don’t have. Failure is a great way-station on the road to success.

But the big reason why the 37Signals guys are wrong is that if great entrepreneurs had taken their advice, they would’ve failed.

The companies that are right for VC are companies that want to establish themselves as leaders in new markets or disrupt incumbents in existing markets. Even when there’s a clear business model, the economics of these kinds of ventures simply require that they get to scale before they get to profitability, because otherwise they get crushed either by competitors who do get to scale, or by the incumbents. And this, in turn, requires that they take outside capital.

Maybe the best example of this, ironically, is the company that was started by 37Signals’ only outside investor, Jeff Bezos. Amazon famously did not turn a profit until 2003, a full eight years after being started. But few people are aware that Amazon.com was not, in fact, the first online book retailer. That honour belongs to Wordsworth.com, a now quasi-defunct, well, online book retailer. The Wordsworth people wanted to grow slowly and cautiously, but instead of just missing out on one of the greatest multibillion dollar opportunities in history, they ended up dead. Why? Because they didn’t realise that they were in a new market, and that new markets are land grabs where getting to scale early matters more than profits in the short run.

Of course, you can tick off the countless other examples: Google, EBay, Facebook, Twitter… Even Apple, which sold boxen and therefore had an inherently profitable business model, but still needed an investment from Don Valentine to finance working capital and scaling. Twitter is another great example, because it’s typically the kind of company that needs to prove the usefulness and adoption of its product before it can monetise it. Even contemporary startups. Tumblr is a fantastic and very successful blogging platform, but could they have built a profitable business requiring a subscription fee from everyone from day one? And given the scale they have now, who doubts they can eventually be profitable by selling premium services? Same thing with a company like Hunch: they have a fantastic product that clearly has potential to change the world and be a cash gusher at scale, but I have no idea how they would go about it if they had to turn a profit now.

So sorry, David and Jason: sure, VC isn’t right for every company, and if someone can build a big profitable business without VC, great, but VC is great and I’m really grateful that most of the world’s great entrepreneurs never took your advice.

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