I wrote in the past that sometimes you can take too much money - doing so creates certain expectations for an exit that might not be achievable and limits your flexibility. In the context of the discussion last week, I think it's important to highlight that these economics are not always the fault of the venture capitalist. For example, Jason Calacanis said you should take as much money as you can get and Marc Andresseen said “in general, [you should raise] as much as you can”.
Billions or Bust
Another one of my favorite recent examples is Slide, founded by Max Levchin of PayPal fame. Slide recently raised $50M from T-Rowe Price and Fidelity - giving up 9% for a pre-money valuation of roughly $500M. Granted, T-Rowe Price and Fidelity probably aren't quite expecting the same kind of returns over the same time frame as a VC, but it still sets a ridiculous high floor for an exit.
That is, in part, the plan. As Sarah Lacy put it, "Levchin, who co-founded and later sold PayPal, wanted to prove he could do it again - this time, generating more than the $1.5 billion PayPal fetched from eBay in 2002." Lacy defends that valuation not because of what the company is worth today, but that it's a "swing-for-the-fences play" which requires a lot of money - and if their plan works then it will be worth far more.
But, as one commenter on the BITS article points out, "the idea that Slide and RockYou 'add the bulk of perceived value to the consumers of these Web platforms' is misguided and should be a warning sign to Slide’s investors. Facebook only opened up to 3rd-party applications in May , and it was doing just fine before that." (Still many others would say that some of the applications that Slide and competitors put out detract from the value of Facebook, but that's a separate argument).
Regardless of what you think of Slide, they've basically taken a lot of otherwise attractive exits off the table. They truly have forced a "$1.5B or bust" strategy - the possible end game here is either an acquisition by a very select group of players or an IPO.
The downfall of taking too much
In discussing how much an entrepreneur should raise, Mark Davis lays out four important goals: avoiding bankruptcy, achieving milestones, minimizing time spent on fundraising, and minimizing dilution. On a separate post, he also highlights a few other reasons why you might not want such a high valuation. In short, Marc says that you limit access to sophisticated money in both the short- and long-term.
This got me thinking, so I'm just going to throw it out there: When you think of smart, sophisticated money in the Internet space, do you think T-Rowe Price and Fidelity? And - let me preface this by saying I don't have any details or context here - but isn't it at least a little interesting that The Founders Fund and Mayfield - funds you would consider sophisticated in this space - didn't participate in this round?
Why do they do it?
All three of the guys I've discussed here who have raised "too much money" or are talking about getting as much as you can have all been successful entrepreneurs... but for the most part didn't need this kind of money to do what they did in the past.
There are a few thoughts that come to mind.
At some level, because they can. You might make the argument maybe the serial entrepreneur has transcended the need for sophisticated money. If they no longer need the guidance from the VC, T-Rowe's money may come cheaper and more plentiful. Or, if you want to look at it more cynically, the entrepreneur can take advantage of less sophisticated investors who maybe don't quite understand the space but do understand their previous successes.
Raising the stakes. Some have suggested to me that it’s just that these guys have the luxury of betting big now; that by raising this kind of money, they are just upping the ante. The thing is, unless you intend on buying a lot of other companies, it’s not clear how some of this money helps beyond a certain point. And, as I mentioned, these guys bet big in the past with more modest purses and won.
After having done it once, these guys may be better able to deploy the money quickly. Hiring will be easier for them since they have a track record and past employees. They know where wish they could have put more money last time and will in theory be able to scale up more easily. (Of course, as we know, the mythical man-month applies here - throwing more resources at developer talent doesn't necessarily translate into better output.)
Ego. Neither of the three guys I mentioned need the money. These companies aren’t about getting rich, they’re about creating a legacy – and legacies are not built around reasonable successes.
I think these things all factor in at some level, along with many other issues. Maybe Jason is just stockpiling for a coming recession, but I would have to think his investors are not intending on having that money sit around for a rainy day. He had to have had a plan to spend that kind of money and show how it can grow the company accordingly.
And in case it wasn’t obvious: for the record, I'm certainly not calling any of these guys out. They have all had greater successes than I have, and I have immense respect for them - I just find this pattern very interesting.
What are your theories? Any serial entrepreneurs want to chime in?