Would you give up everything if it meant you’d have the opportunity to come away with millions? This is the question entrepreneurs face when, after exhausting all funding sources, they consider approaching a venture capital firm.
Of course employing a venture capital firm doesn’t have to be a bad thing. Just ask Mark Zuckerberg, Sergey Brin and countless other entrepreneurs whose fortunes were made alongside the guidance and deep pockets of such institutional investors. For many startups, securing VC money is the golden ticket to successfully disrupting an industry and experiencing meteoric growth.
Last year, $29 billion of VC money was invested in startups, according to the National Venture Capital Association. VC firms so far this year are actually funding fewer projects over last year, which means the competition for dollars has increased.
The Moxsie Affair
Jon Fahrner is all too familiar with the pitfalls of VC funding. A former early employee at Zappos, Fahrner saw the great things institutional money could do for a fast-growing tech firm. In 2008 he was excited to join Moxsie.com, another VC-backed business, this one offering an e-commerce platform for budding fashion designers. The difference: Moxsie was in survival mode whereas Zappos had been in rapid growth mode.
Fahrner was hired as vice president of e-commerce for the site, but was soon promoted to CEO. Moxsie already had around $4 million in VC money and needed more, so Fahrner and his team started knocking on doors. But they encountered a uniform response.
“Between 2008 and 2010, VCs were only interested in the private sale/daily deal model like Groupon,” Fahrner says. “They told us e-commerce was a dated model that was dying.”
Fahrner’s existing investors were starting to agree. About 18 months into his leadership, Fahrner walked into a board meeting when a board member, who was also a main investor, proposed Moxsie officially change its business to the private sale model. Fahrner was completely blindsided. He believed strongly in the current model and knew the company was gaining traction in the marketplace; already it had a network of 100 independent designers and a social media following of more than 250,000 people. He pushed back to no avail. He wasn’t only up against a majority owner in the company, there was also the intimidation factor: His investor was funding companies being acquired for hundreds of millions of dollars.
“When you are a just a $2-million company fighting for a business model, it can be pretty hard,” he says. “I just had to sit there and take it.”
Fahrner left Moxsie a little more than two years after joining. Since then, the company was acquired by Fashionstake.com
, which was then acquired by Fab.com
In June 2011, Fahrner launched Bumebox
, a Palo Alto, Calif.–based company that provides a social media platform for brands. He’s taking things slowly, signing one client at a time. VCs are not in the mix, although many are showing an interest in investing, he says.
“Part of my goal is not only to build a product, but to get a few people to pay for it and get good data behind it,” he says. “I want to put these things in a row before we start fundraising so I can control the path we take.”
Fahrner’s plan seems to be working. The company is already turning a profit, and in early September was entertaining 12 clothing-brand clients at New York Fashion Week.
Drawing from past experiences, Fahrner is clear about his plan to not give up control of his company or business model. He does plan to enlist VC funds at some point, but will be strategic about choosing his partners.
“I am in a better situation now,” he says. “I can pick the people who I want to work with who share my vision.”
Finding Value in VC
Seth Rosen, on the other hand, is thrilled to have venture capital backing. He is co-founder and chief operating officer of CustomMade, a virtual marketplace for artisanal goods. Unlike Moxsie, a company that was in survival mode, CustomMade was in growth mode when Rosen and his team sought out institutional investors.
“We saw low-hanging fruit and just needed the money to buy a ladder to go and pick it,” he says.
Rosen doesn’t feel as if he has given up anything by signing with VC firms. Instead, he says his investors are thought of as partners that just bought a piece of his business. Today, CustomMade continues to support its community of local businesses and provide value to its customers through its custom handmade goods.
Several factors can lead to the dissolution of a VC/entrepreneur relationship. First, both parties need to take ample time to get to know each other before signing.
“Talking to any sort of investor should be like dating; you don’t get knocked up on the first date,” says Erika Napoletano
, branding consultant and author of The Power of Unpopular: A Guide to Building Your Brand for the Audience Who Will Love You.
At Freestyle Capital
, a San Francisco–based VC firm specializing in seed funding, co-founder Josh Felser says he and his team usually chat with entrepreneurs for at least two months before reaching an agreement.
“The longer you take, the more likely it will work,” he says.
Miscommunicated expectations can also lead to bad relationships. From the entrepreneur’s point of view, it is important to research the reputation of the VC firm and its partners. Felser recommends logging on to The Funded
, a VC rating site, to get the inside scoop on what to expect from each firm and partner. Note: pay close attention to the partner on your deal, he says. That is the person who will have the most contact with you and your team.
Relationships can also turn sour when parties disagree about a pivot in business direction (e.g., Fahrner’s situation). Felser says these clashes are less common at the seed level, more common in later stages when things aren’t going well.Drawing from his own experience at Moxsie, Fahrner recommends entrepreneurs bootstrap as long as possible before enlisting the help of a VC.
“Ask yourself if you are trying to get money for your company to survive or for your company to grow,” he says. “If you are trying to survive, that means things aren’t happening the way you hoped and it may save people a lot of time and money to just end it and start something else.”