There’s a new animal stalking Silicon Valley, one of our very own creation. It’s the one-round startup.
Most remain convinced it’s nothing more than fictional – a Silicon Valley unicorn. But in our industry today we hear talk of it constantly. The startup that wants all of its money up-front.
By raising capital in one round, so the story goes, it frees itself to focus on its business while reducing the chance that venture capitalists will come in and further dilute it to nothing.
In many ways the one-round startup makes sense, and in equally many ways it makes no sense at all. In fact, in all but the most optimal situations (namely, only those companies with proven business models, customers and financials near cash-flow positive) the one-round startup represents just another knee-jerk reaction to a market that went from doling out money far too easily to one where raising capital has become far more difficult and time consuming.
Still, from angel-backed startups to portfolio companies seeking second chances, startups across the board are seriously considering raising just one round of funding as their optimal strategy of capital formation. Such a trend has implications for VCs and entrepreneurs alike, even more so now that institutional money flows into VC funds through eyedroppers rather than garden hoses. To potentially waste such resources on a poor funding decision – particularly one limited to just one round – is no longer acceptable, nor easily forgiven.
Pros and Cons
Mark Biestman, President and CEO of Managestar, one of Charter’s enterprise software companies, understands the process of raising capital all too well. Biestman joined Managestar from Seven Networks, where he served as president and CEO, overseeing its global mobile data business. Prior to that he was senior VP of worldwide operations for Commerce One.
For Biestman, the one-round startup is no easy issue, representing a complex grid of trade-offs.
“In its favor, doing just one round means cash on hand when cash is king, thus giving management the ability to focus on its business, on attracting, recruiting and retaining top talent, while allowing a company to be aggressive with its business plan right out of the gate,” he says. “It’s also a marketing weapon for validating the company in front of customers, while lowering the potential dilution for founders, management and employees over successive rounds.”
However, in more subtle ways, the one-round strategy allows for potential complacency within the startup team, something that an early-stage company can afford.
“Doing multiple rounds at least forces constant adjustments to the business model,” Biestman says. “It forces you to chew up the model and constantly tune it to the market while forcing management to be as focused on the market as it is inwardly directed on the business.”
Between the pros and the cons, Biestman has an optimal model for fund-raising, one with lessons worth heeding by VCs needing as much strategic help in getting their companies to liquidity as startups need in getting their companies to profitability.
“What we really need is the combination of a sizable up-front round along with the intent to encourage strategic investors to enter in future investments along the way,” Biestman says.
The due diligence process of multiple rounds is far too time consuming and distracting as it exists now.
“And much as we commiserate about public companies needing to be too quarterly focused, private companies with lots of investors are much the same way, always having to report to investors how the quarter is going rather than focusing on building long-term value within the business,” Biestman says. “What we need is a true model focused on customer orientation where customers themselves become your investors.”
The Spam Angle
Perhaps the closest thing to Biestman’s optimal model – though one yet to have landed any customers as strategic investors – is a company called Corvigo, a Mountain View, Calif.-based anti-spam company.
Unlike many other anti-spam startups, Corvigo has a unique approach to filtering out unwanted e-mail. It uses technology based on artificial intelligence to interpret the intent of messages, essentially reading language patterns to determine whether email qualifies as spam.
In January 2002, CEO Jeff Ready started Corvigo along with three colleagues. On the funding side, the founders were bound and determined not to take any outside capital, particularly for the first year. They would live on bread and water – or in Ready’s case, “bottom-shelf macaroni and cheese” – if they had to. At one point they even lived with each other to save on rent. “I think anybody should be able to start a company, build a product and begin selling it to customers without very much money at all,” Ready says now.
Sequoia Capital had already looked at the anti-spam space but had essentially written it off. It was too cluttered as far as Sequoia was concerned, with one startup looking very much like the next. Ready, for his part, had written off venture capitalists.
Ready, like Biestman, is a pretty smart guy. Schooled in computer science from Terre Haute, Indiana, the technology entrepreneur had already built and sold an Internet service provider as far back as 1996. He went on to start one of CMGI’s few profitable and successful Internet advertising investments with his next venture, Radiate Technologies.
Ready is that unique blend of an entrepreneur who understands technology at a granular level, can apply it to a business model that solves a true point of pain and has the communications and people skills to inspire those around him.
He’s also no dummy when it comes to raising capital, particularly after being schooled by the VCs at CMGI. In this sense, Ready was looking to hook up with Sequoia as much as Sequoia was looking to find an anti-spam startup.
With Radiate, Ready and his other two founders had poured their winnings from their first company into this, their second, and were building the company to profitability without any venture capital at all. Yet, heeding to the hype of the times, Radiate took a first round of $5 million from CMGI, an investment that included a 7x liquidation preference for the VC.
Interestingly, Radiate didn’t even need the first $5 million or the second $1.5 million it raised soon after. It was funding itself through an expanding business until the Internet advertising market literally collapsed in mid-2000.
“Prices dropped by 96 percent,” Ready says. Instead of folding, the company used CMGI’s capital to restructure, build the company back to profitability and eventually sell to Digital Candle, a Seattle-based company, at the end of 2001. CMGI took the winnings – or whatever was left after the sale – and everyone else was left with nothing.
The lesson for Ready was that even one venture round might be one round too much.
A Rare Breed
But what Ready built with Corvigo could now be seen as one of the few examples of an optimal one-round startup. Corvigo has already achieved cash-flow positive financials on its own, even after less then two years in business. It has significant revenue and customers (sales should eclipse half a million in the fourth quarter, and OPEC and Purdue University are clients), and the company realistically only needed additional capital as a sales and marketing round.
By raising $5.5 million from Sequoia, Corvigo gains all of the advantages of having money in the bank that Biestman describes above – stability, recruiting talent, marketing power with customers, business focus, etc. – without having the distraction and dilution effects of having to raise multiple rounds just to stay in business.
Thus, for an advanced-stage startup that’s done much of the heavy technology lifting and customer pitching on its own, the one-round strategy makes a lot of sense. Entrepreneurs get a chunk of capital with which they can jump to another level in terms of sales and marketing. VCs get a polished business where the true operational and networking values of the firm’s partnership can be put to use, with the added benefit that the new portfolio investment just might be that much further down the runway toward liquidity for a firm’s LPs.
Such examples, however, are few and far between. Many companies searching for their one round of funding have yet to experience the growing pains of figuring out products, pricing and a cost structure that meets the shifting demands of their market. These would not make good one-round startups.
For VCs, it becomes the simple question of: “Is this the right deal for management but the wrong deal for myself and my limiteds?”
It’s one thing to bet on a company that simply can’t make it – we all do that. It’s another thing to give away too much capital too soon, representing too much of a cushion for early-stage mistakes. Thus, the optimal one-round startup has its place in venture capital portfolios, but the qualifications for earning that status must be fairly rigid, since the benefits to investors must be equally weighted against the numerous opportunities it gives to entrepreneurs seeking such a gift.
Ravi Chiruvolu, a general partner of Charter Venture Capital, is a regular technology columnist for VCJ. Chiruvolu specializes in enterprise software, software infrastructure, e-business and wireless technologies. Send feedback to