This is a guest post
Every day we read news about numerous startups and companies getting funded with plenty of cash. Initially, it seems like good news, but seriously, it does the whole SaaS (software as a service) ecosystem more harm than good. Most (although not all) VCs today are playing (the) “cash-rolling game”: They invest in companies without long-term sustainability in mind.
Some real life examples we’ve seen in recent years:
-Intuit acquired Mint.com (free financial solutions) for a whopping USD170 million. Do you think a company the size of Intuit doesn’t have enough marketing budget or couldn’t build killer features to win over Mint.com users? No, Mint.com is free and it was hurting [Intuit's own business] badly.
-If you are a VC and your investors let you manage a huge amount of money, are you going to invest in companies that are not profitable yet (some don’t even have a clear business model) like Twitter, Foursquare or Quora? The reason is simple: Social and community-based solution can grow at an extreme speed that is beyond your imagination. Remember, the size of a user base does not necessarily translate to revenue or profit directly!
-How many companies have AOL and Yahoo acquired in the last 10 years? Did they get any benefit or increased profit from those acquisition? No, they ended up killing most of them.
So, why do VCs behave this way?
1. VCs typically invest in people with a track record of supersizing a company by burning lots of cash within a short time
2. When a new startup appears with something cool, VCs pump in money regardless of whether that product or service can help to improve people’s life for at least a decade. A long-term sustainable business should be able to bring value to people for at least 10 years.
3. With plenty of cash to burn, the founders start various high-stakes investments in a race against time. Their focus is on speed, not long-term company growth or business benefits. These activities include unnecessary massive hiring in a short time, technology acquisition to speed up product development, making sure everyone talks and knows about them while reminding the public often (marketing), customer acquisition (yes, buying customers) by giving incredible offers and most of the time [the service or product] is free.
4. The ‘acquired’ customers will just use their product or service anyway unless it’s not free, more cash is spent on building the hype around how fast and successful that company is growing with millions of revenue in a short time. Valuation starts to increase as its revenue rises.
5. Repeat step three and step four for two to three years until:
Exit A: The company’s (incumbent) competitors get hurt and they have no choice but to acquire them to stop them from damaging the whole ecosystem.
Exit B: Going for IPO and start sucking money from the public, as the initial hype about the company will push up its price. Prices will however drop to the bottom eventually when that bubble bursts.
Whether it’s exit A or B, the VC happily walks away with his money — probably a sum of around 10-20 times his original investment.
My personal experience:
Our company was approached by a VC from the US (about the size of Sequoia Capital) previously. Although the deal didn’t work out after several communications, from my personal point of view and analysis, all it wanted from us was to push our revenue to an eight-figure amount within two years and for us to cash out by proceeding to exit A or B (as above).
It didn’t seem to matter to the VC at all if our company would continue running or growing in a healthy way after exit — it’s all about a hit-and-run business model.
Want to get VC funding for your company? Think again. If you want to build a long-term, sustainable business, you should not take VC money. Growing slowly is OK, make sure it is consistent and healthy.
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