May 31, 2003 - VCs are not
Degenerate Risk Takers (plus GEM and GolfServ)
by
Bill Snow
One of the most prevalent
mistakes early stage entrepreneurs make is to totally and completely
miscalculate the role of venture capital in their business aspirations. This
reality drove me so batty that I created
Venture Capital 101, a document that dispels the myths about venture
capital, and provides entrepreneurs with a road map for growing their
companies.
EPrairie contacted me about doing a weekly column -- looks like it will
be called VC101. I've reprinted my first column below. I'll focus on the topic
of venture capital, especially as it relates to early stage entrepreneurs. I’ll
detail what characteristics make companies “venture worthy,” while painfully
exposing the mistakes that make VCs run for the hills. This column will look at
current trends in venture capital, profile some Chicago-area companies, and get
the inside skinny from Chicago-area investors.
Global Entrepreneur Monitor
Speaking of early stage
entrepreneurs and venture capital, the Global Entrepreneur Monitor (GEM)
surveyed 37 nations, and reported that some 286 million people in these 37
countries are involved with some sort of entrepreneurial pursuit. I thought
some of the numbers in this report made a compelling case for the difficulty and
scarcity of venture capital. Here’s the
link
to the report if you’re dying have your eyes gloss over:
According the GEM survey, there
are:
* 286 million entrepreneurs (in
the 37 surveyed countries)
* 20 million entrepreneurs who
think their companies might be venture worthy (in the 37 surveyed countries)
* 12 million entrepreneurs
representing 6 million start-ups (US only)
And from the National Venture
Capital Association we know there were about 3000 companies in the US that
received venture capital during 2002.
These numbers reminds me of a
movie where the freshman class is assembled in the gym. One of the school
administrators says, “look at the person to your left, look at the person to
your right, only one of you will be here in 4 years.”
In a similar vein, I invite
early stage entrepreneurs to get to know 8,000 other early stage entrepreneurs.
The odds say only one of you will ever receive venture capital.
The big misconception
Let’s look at some of the biggest
misconceptions about venture capitalists: the notion that they are degenerate
risk takers, have money to burn, and are willing to take flyers on 100 unproven
concepts in order to hit one homerun of Microsoft-esque proportions.
The reality is that venture
capitalists are not degenerate risk takers. They do not invest in early stage
(e.g., pre-revenue) companies. They do not take risk so much as they manage,
mitigate, and frankly, avoid, risk. Unfortunately, too many entrepreneurs do
not know this. Perhaps these entrepreneurs have bumped their heads and they
think they live in Sweden. They seem to have developed a horrible sense of
entitlement.
Sense of entitlement + bitter
reality = many wasted steps
A “how to be a better golfer”
joke made the Internet rounds a few years ago. The number one suggestion was,
“if you want to be a better golfer, go back and start at an earlier age.”
There’s a similar lesson for many entrepreneurs trying to raise funds in the
difficult post 9/11 market: “If you want to get venture capital funding, go back
and be a better entrepreneur.”
The bitter reality aspirant
entrepreneurs need to face is that venture capitalists are returning money to
their limited partners. While venture capital deals are graded on a very steep
curve, being the best of a sub par group will not yield investment. If the
choice is investing in lesser companies or returning money to investors, venture
capitalists choose the latter. Many entrepreneurs, especially in the boom time
of the late 1990’s, developed a sense of entitlement where they thought if they
came up with a novel enough idea, venture capitalists would fund them, sight
unseen. The truth is venture capitalists did not operate this way in the 90’s,
and they certainly do not operate this way in 2003. It is safe to assume they
will not operate this way in 2010, 2020 or at any other time in the future.
An entrepreneur who dives into
the world of venture capital armed only with a misguided and unprepared sense of
entitlement will meet with bitter reality, resulting in wasted steps, for both
the entrepreneur and the venture capitalist.
GolfServ
Speaking of golf and realistic
entrepreneurs, let’s look at a recent Chicago success story…in the making.
GolfServ, which manages the content for over 200 golf related websites, recently
raised $1 million from a group of local angels, including Bill Weaver and Steve
Miller. On a recent Sunday afternoon, Mike Lazerow, CEO of GolfServ, joined my
foursome at Pine Meadow Golf Club. While watching Mike consistently (and
annoyingly) hit fairway after fairway, we discussed GolfServ as well as some of
his philosophies.
Mike is an experienced business
builder who knows the ups and downs of entrepreneurship. While still in
college, Mike started University Wire, which eventually merged with Student
Advantage. The company, trading under the symbol STAD, went public in June 1999
at about $8 per share. Over the next 6 months STAD rode the NASDAQ wave,
eventually peaking at almost $30 per share (or almost $300, adjusted for splits)
in December 1999. All good things end, and STAD has come back down to earth,
and despite almost $60 million in revenue, the stock languishes in penny stock
territory, and currently trades over the counter.
Having seen the ups and downs of
entrepreneurship, Mike is imbued with a healthy sense of reality. He knows
GolfServ’s current business model, which is heavily dependent on ad sales, is
not a “venture worthy” deal. A revenue model driven by ad sales is heavily
dependent upon hiring more and more people who can only be expected to produce
at a certain level. It is difficult to get higher and higher levels of
production from each person because there is a finite amount of time in every
day, every week, every month. People can only make so many calls in a given
workday. There is little or no scale in this model, and as such, VCs tend to
avoid these kinds of deals.
Mike knows this, and he isn’t
planning to look for venture capital. Instead, in what should be lesson #1 for
all entrepreneurs, he is concentrating on building a business. Mike the realist
knows GolfServ’s current revenue potential might be a $10 million a year
business. Nothing a VC would consider, but not bad for a privately held
company. Let’s face facts: the CEO of a profitable $10 million a year company
will live a very nice lifestyle, there’s nothing wrong with this goal.
Telling, there’s more to
GolfServ’s story than an ad driven business. In February 2003, GolfServ
introduced an on-line subscription service, and in June, the company will unveil
various enhancements. For $30 per year, golfers will be able to keep their
handicaps on-line. GolfServ current has about 10,000 paying members, and hopes
to have 40,000 by year-end.
This model becomes the type of
thing that scales, and VCs find interesting. Do the math: according to Mike
there are about 26 million golfers in the US. For every one million golfers who
sign up for the service, GolfServ will generate upwards of $30 million in
revenue. Instead of relying on advertising sales, GolfServ will utilize what I
call the “customers sitting in their underwear buying things at 3 am” business
model. Any revenue generated from ad sales will be gravy on top of a very
dynamic (and profitable) business. Smart.
“Do one thing well”
After watching Mike hit a couple
of 50-foot putts to within “gimme” distance (for pars), we talked a little about
some of the other things he does well. Not surprisingly, Mike is a big
proponent of the “do one thing well” philosophy. GolfServ isn’t trying to be
all things to all people. The company GolfServ is focused on one thing: being
the preeminent on-line resource for golf. As Mike says, “we want to be the
Yahoo of golf.”
Has your company been profiled by Bill Snow? Send
an email to introduce your company:
bill@billsnow.com
About the author
Bill Snow runs this site. If you haven't figured that out yet, I can't
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