Increasingly, start-ups opt to go it alone

By Scott Kirsner, 8/11/2003

Perched on the credenza in Dave Watkins's office are four reminders of roads not taken. They're framed term sheets, offers from venture capitalists to invest in Softscape, the Wayland company that Watkins cofounded with his father and brother.

"Some wanted more than 50 percent of the company," says Watkins. "Others didn't value our intellectual property as highly as we did, and they all had a three- to five-year exit plan, when they expect to cash out."

Watkins isn't an anomaly. He's one of a growing group of tech entrepreneurs who are deciding to forgo venture capital investment -- at least for the time being.

A venture capital infusion of $10 million or $20 million, during the late 1990s, served as a kind of pedigree. But today, entrepreneurs are equally proud of financing their start-up on their own, with credit cards and second mortgages.

"Having discipline is really important," says Phil Sipowicz, chief executive of Everynetwork, an IT services firm in Waltham. "When you're bootstrapped, you don't have $20 million sitting in your bank account to wildly spend on office space or a Porsche that you want to give away to the next employee you hire. It forces you to produce for your customers."

In any economic environment, some entrepreneurs opt to bootstrap, building on customer contracts, bank loans, or government grants. But two dynamics are combining to promote even more bootstrapping than usual.

First is the near-paralyzed state of many established Massachusetts venture firms.

"The whole industry seems to be licking its wounds right now," says Sam Levine, chief executive of Intellireach, an e-mail management software firm in Dedham. "When we'd talk to venture capitalists and ask how many investments they made last year, there would usually be a long pause. They've been looking to shore up existing investments in their portfolio, and they've been concerned about the flight of their limited partners." (Limited partners are the institutions, like pension funds, that supply venture capital firms with money to manage.)

Second: When venture capitalists do make an initial investment in a technology company, these days they prefer that the company is more mature.

"A typical start-up now may be a half-dozen people with a prototype or beta product, and even a few customers," says Chip Hazard, a partner at IDG Ventures in Boston. "They're much further along than they were in the boom, when it might've been two guys and a deck of slides."

Entrepreneurs have a litany of reasons to explain why they're eschewing venture capital.

For Brian McKernan, chief executive of Agencourt Bioscience Corp. in Beverly, one reason is excessive oversight. McKernan talked to one prospective investor who demanded he hold a board meeting every four weeks. "I said, `My God, I'm supposed to be running a company.' Preparing for a monthly board meeting would've turned into a major chore."

Agencourt, which sells products that help pharmaceutical companies purify DNA as part of the drug-discovery process, instead raised $5 million of individual "angel" investors and a corporate partner.

Oddly, McKernan says that many investors wanted to hand him too much money.

"Smaller deals aren't as efficient," for venture firms, he explains, because each portfolio company requires about the same amount of the firm's time. "They wanted to put in 10 or 15 million, and when that kind of money's in the bank, you tend to spend it. We just didn't need that much."

At Softscape, which sells employee management software to human resources departments, Watkins was bothered by the quick-flip outlook of some investors. "We're in a market space that hasn't peaked yet, but all of them had a built-in exit plan, where they expect to cash out in five years or less," Watkins says.

Softscape, founded in 1996, was named earlier this month as one of the 50 fastest-growing technology companies in New England. Watkins says he expects the company to bring in $18 million in revenue this year -- an increase of 70 percent over 2002.

Chasing venture capitalists can also be time-consuming, and many entrepreneurs would prefer to dedicate themselves to chasing prospective customers.

"Talking to VCs takes a tremendous amount of time, and I'd prefer to focus on the business and making it more successful," says Levine at Intellireach.

And over the past several years, venture capital firms drew up term sheets that stacked the odds of a big payout heavily in their favor -- short-changing the start-up's founders and any previous backers.

"They're very interested right now in eliminating as much of the downside risk as they can while grabbing as much upside gain as possible," Levine says.

"When the markets cratered, the venture guys were putting the screws to everyone," says McKernan. "They wanted to make up for all of the losses of the dot-com era. But it's not my job to make up for those losses."

Of course, McKernan and the other entrepreneurs quoted here won't rule out the possibility of taking in venture capital money at some point. But given the current state of the VC community, and the individual circumstances of their companies, the timing hasn't been right.

It's fun, though, being in the catbird seat. Last week, when I called Carl Nelson, chief executive of Integrity Interactive, he told me that he'd gotten a call from a venture capitalist earlier in the day. "He was not heartened to know that we don't need money right now," says Nelson, adding that his 50-person company has been profitable for seven quarters. The Waltham company provides Web-based ethics training to corporations, clearly a growth business.

"The problem venture firms are having is that they don't want to invest in the great majority of companies," Nelson says, "and the few that they would [want to invest in] generally don't want their money. It's a difficult time."

But venture capitalists aren't worried that they're headed for obsolescence.

"Sure, it makes sense for an entrepreneur to [bootstrap for a while] and raise money when they can get a higher valuation for the company, and give up less of it," says Hazard at IDG Ventures. "But I don't get the sense that the entrepreneurial world is saying, `We can live without you.' I think there's always a role for constructive capital."

Tim Barrows of Matrix Partners observes that many products, from medical devices to telecommunications equipment, cost more to develop than an entrepreneur can charge to his American Express card.

"If you build a business that's succeeding," Barrows says, "it'll attract competition very quickly. At some point, you have to step on the gas and raise outside capital."

But is VC funding a prerequisite for success? That myth seems to be crumbling.

In the late 1990s, companies without venture backing "were considered very unusual," says Nelson, of Integrity Interactive. "How could you possibly start a company without a venture capitalist involved? At times, we felt that we were making a mistake. But I think that has changed."

Scott Kirsner is a contributing editor at Fast Company. He can be reached at kirsner@att.net.