Venture: Does venture capital help - or hurt - a business?

37Signals founder Jason Fried is a contrarian who likes to poke holes in the conventional wisdom of the tech world. That includes arguing that venture capital can hurt instead of help a startup company.

July 25, 2011

By Ashley Gross and Kate Springer

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This week, engineers and entrepreneurs are converging at TechWeek – a showcase of Chicago’s burgeoning tech scene.

Many startups hope to entice investors to plunk money into their ideas. But one Chicago software executive says getting venture capital is exactly the wrong thing to do when starting a business.

Venture capitalists have money to burn these days and they’re racing to get a slice of the next Facebook or Twitter. But there’s a guy with a successful software business in the West Loop who says “Just say no.”

TAPE (buzzer sound): 37Signals.

GROSS: Oh hi, this is Ashley Gross here to see Jason Fried.

Jason Fried and two others started a company called 37Signals in 1999, just as the last Internet bubble was cresting. They each put in $10,000, but they never needed that money because they landed customers right away.

Once they started to get some success, he got so many emails from venture capitalists he said they started to seem like those scam emails promising to wire a million dollars to your account. He said thanks, but no thanks, and now he’s kind of an evangelist against venture capital. He’s even started a series of company profiles on the 37Signals blog called Bootstrapped, Profitable and Proud.

I asked him what’s so wrong with venture capital.

FRIED: I’m mostly opposed to it upfront. So most people don't go out and raise money, but in the tech world a lot of people do. The first thing they do is think about how to raise money right when they're starting, and I think that's the wrong time to do anything like that. Ultimately, I'm not opposed to taking investment way down the road if you're profitable and you want to do something else, but that's a different scenario than when you're first starting. The reason why it's bad when you first start is that it takes certain pressures off you, which sounds like a good thing but it's not a good thing if you're trying to build a business. And the pressure it's taking off you is the need to have to make money. If you don't have to make money, then you don't have to make decisions that matter about making great product, and treating your customers well because you have someone else's money to spend. I think you want to have no money in the bank and in some ways feel desperate and feel like you have to be scrappy in order to start making your own money.

GROSS: And you had told me that it makes companies feel like they have to grow really fast, right?

FRIED: Yes, especially in the tech world, which is what most of these companies are. There are pretty much no costs to entering the business anymore. You need an Internet connection, you need some computers, you don't need an office, you don't need a lot. So what you can spend money on is one of two things - marketing, which you don't have when you don't have a product to market yet. And the other one is hiring, because people will be the most expensive thing you'll ever have, probably. Occasionally you'll have a big expense, but mostly your salaries are what's expensive. So when you have a million bucks in the bank, if you only hire two people, what are you doing with the money? So you've got to spend that money, that's what it's there for. It's there to spend. And they want you to spend it because they want you to come back for more. Very, very few companies have one round of funding. It's like they get addicted to it and have to come back for more, and the VCs want you to spend it, and hiring is a great way to spend money. And again, I think the wrong thing to do upfront is to have too many people working on a problem. You want to have fewer people working on a problem upfront, so you can be as efficient as possible and creative. When you have all the resources in the world and all the people in the world, things slow down, they don't get faster. And you don't come up with better solutions, you come up with worse solutions that are more complicated, more complex, and those again are the wrong forces, especially early on.

So, venture capitalists of the world, defend yourselves. I called up a veteran of the VC world, Matt McCall, to speak on their behalf. McCall is a partner with New World Ventures, which is controlled by members of the Pritzker family.

He says venture capitalists help companies in a number of ways, including:

MCCALL: Capital, external validation, a very large Rolodex.

For example, getting the stamp of approval from New World Ventures can help grease the wheels for a brand-new company.

MCCALL: One of our companies right now proudly touts – he goes into close deals and they say who’s your backer and he says the Pritzker family. It brings instant credibility. They kind of check off the box, okay, financial stability, don’t need to worry about that.

And McCall says he can help businesspeople avoid mistakes because he’s witnessed a lot of companies implode.
Jason Fried of 37Signals says yeah, definitely, that advice and those connections can be valuable.

FRIED: But you have to think about how valuable is it in comparison to what you’re giving up. There’s lots of valuable things, but is it worth 30 percent of your company? Is that advice or connections? Maybe they are. There’s certainly some incredibly smart people in that world, but I’m sure there are quite a few others and I know there are because I’ve heard many stories of this – of them giving the money and the advice is not very good at all. And it’s clear their advice is just being positioned to sell something, to build something to a point to sell it, not to make something great for customers who are using it.

Fried says he still gets emails from venture capitalists eager to invest in 37Signals.  

Instead of accepting, he turns around and makes jokes. Two years ago, he put out a fake press release saying 37Signals was now worth more than $100 billion after an investor bought 0.000000001% of the company for a dollar.

He says he’s happy to just focus on making profits and skip the investment bubble altogether.

And now for this week’s Windy Indicator.

That’s where we veer off the main roads on to the side streets of the economy

Today — The Neighborhood Bike Shop.

AMBI: he’s looking for a bike...

Lesley Tweedie wasn’t really sure what they were getting into when she and her husband Alex opened Roscoe Village Bikes in 2007.

Turns out…

TWEEDIE: The bicycle business tends to be a little bit recession proof.  The bad economy actually inspires people to ride.

Revenues reflect that. Tweedie says business has gone up each year since they opened … and still seems to be increasing.

She counts competitive bikers, commuters and families with kids among those riders ... and shoppers.

AMBI: Kids playing with bells; phone ringing

Though her bike shop is thriving, Tweedie says that some of her customers are feeling a financial the pinch.

TWEEDIE: I would say at least once a week if not everyday someone says they’d like to get a new helmet or replace a lock but they need to wait a little bit.

The bike shop isn’t selling as many high-end, fancy road bikes this season.

TWEEDIE: “A lot of our customers do come in with used bikes or old vintage things, then we tune them up and get them working as well as they can.”

Tweedie says her tune-ups and repairs are up 20 percent compared with last June -- a sign that more people are updating instead of upgrading.

AMBI: Customers: Like a thumbs up good? so is this the one we’re going to go with? Like walking out with it right now? Okay!”

Next week, the Windy Indicator gets a stitch in time.