This great article by Sachin Rekhi got me thinking. Sachin broadly divides entrepreneurial tactics between those that are trying to create “Fundamental” value:
An entrepreneur that focuses on building fundamental value is optimizing for creating a standalone business that generates meaningful cash flow and profit as an independent entity.
and those that are going for “Strategic” value:
An entrepreneur optimizing for strategic value is one that is building their organization in such a way to maximize potential value to a larger organization that will ultimately benefit from an acquisition.
The argument is that in order to create Strategic value, you may need to sacrifice profitability for several years while you grow your user base, capture advantage with industry partnerships or create some hard-to-replicate value. Those companies looking to acquire the business will need some essential market position or value-add that it would be impractical to try to create themselves.
Mint’s Fundamental Value
For a company such as Mint.com we have an example of a business that was creating fundamental value with a product that gave users insights into their finance while earning the company immediate revenue via affiliate sales deals. This was a profitable business that could quite happily have continued under it’s own steam before it was bought by Inuit. It’s quite probable that the founders thought of Inuit as a potential acquirer, but wisely stuck to their original plan to create fundamental value (and revenue along with it). Despite some industry whinging, it seems to me that it was a good opportunity for the founders to get a return on their hard work.
Why take VC money?
While 37Signals seem to dismiss the entire concept of raising VC money on principle alone, I’m going to play devil’s advocate. The obvious addition of a good chunk of cash to act as a runway can’t hurt. To build up the basis of a strategic value company may take years to create a platform, collect data, or build up a critical mass of users. A venture capitalist may carry the sort of clout that legitimizes your company in the marketplace. A well-chosen VC can also have the sort of contacts that is worth far more than the cash they invest, opening doors in your industry that might be completely inaccessible otherwise. Coincidentally as I finish writing this, Dave McClure announced that he’s part of a panel on this very topic at SxSW.
According to this article from August 2000, Amazon had at least $530 million invested in it. In order to create the strategic value that currently dominates online retailing they burned through huge amounts of capital to build distribution systems, expensive scalable online platforms, huge amounts of content and data entry etc. It seems to be a far riskier play, but if you pick the market, get the formula right, and have a little luck you can fundamentally change how people interact. I can’t envisage a way that Amazon could have done it differently.
Why run away from VC money?
While all clichés may not be true, they surely have some grain of truth in them. The stereotype that a VC will boot out the founders if things don’t go to plan certainly doesn’t happen all the time, but the story doesn’t come from nowhere. The main anti-VC argument that 37signals seem to have is that if you have more money then you’re inclined to spend it less wisely – this is probably valid from simple economics alone. The discipline to ensure the money is used on the important things (or that your VC will be prepared to keep the cash coming) may be the key for companies aiming to create Strategic value.
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