What didn’t work. Part 2: funding

What I’m listening to while I type: Let England Shake

“I love this idea of wrong thinking – of encouraging people who have ideas to go see if they work and not dismissing them just because they sound like the wrong solution. No one has the right answer at the beginning. I made 5,127 prototypes of the bagless vacuum before I got it right.” James Dyson

So, and in case you hadn’t yet spotted it, there’s a page on this site called ‘What didn’t’. Right now it’s just a handful of web-tech ideas that didn’t last, written up as a list. What I hope to create eventually is a database of great ideas that launched and folded – Dyson’s “wrong thinking” legacy.

 @duncanburbidge  pointed me to Techcrunch’s fabulous Deadpool, which tags stories of closures and likely closures. It’s an interesting list but difficult to work with in terms of useful data.

I want the information in the WWWD database to be a) written by the founder/s who were there at the birth and death of the project to provide valid qualitative data, and b) structured so that it can be interpreted by researchers (I’m still working on that, suggestions appreciated).

Anyway, this post is part two of my look at the things that I believe make web-tech start-up success more likely, based on my experience of things going wrong. Number two on my list of five critical things is:

2. Don’t only spend your own money.

It’ll cost you to launch your own web-tech business. You’ll have to spend some of your own money, maybe a lot of it, but my advice is that if you only spend your own money it will fail. You need investors.

I left newspapers in 2006 to work on my first web-tech project, a user-generated news site. Since then I’ve launched Sweeble (web/print self-publishing) and a couple of traditional websites.

But over five years, I’ve only earned about £7k in salary from all these projects. My time for the last four years has been paid for by working part-time at Staffordshire University, teaching web-based journalism for c£17k pa.

The most I earned in newspapers was £35k pa, in 2002 when I was managing editor of a bunch of Northcliffe’s thisis… local news websites. Allowing for the fact that my salary dropped when I went back to the newsroom ‘proper’ as news editor, I could still expect to have earned around £30k a year had I stayed in newspapers and not gone all entrepreneurial on myself.

So far I’ve lost around £75k in salary over five years.  Potentially more if you add that, when I worked for the man instead of myself, I was promoted most years (I’m a bright woman – just clearly bad at being an entrepreneur).

But let’s stick with that figure of £75k as theoretical lost earnings. That’s one cost of my investing time in my several start-ups.

The other is a bit more direct. I’ve also put £18k of my own savings into my business, and expect to put in a further £5k in this financial year. And I owe £10k to family investors that I’d like to think I could repay one day.

So, cost to me of spending five years trying to get my web-tech start-ups to fly – £108k.

I mentioned investment.

The Government has invested in me and my bright ideas with two R&D grants in five years, totalling £27k. Thank you Tony and Gordon.

I’ve had private investors interested several times, had meetings with Angels and VCs and, in 2010, had an offer and term sheet on the table from Midven Ltd for £255k.

However, the issue is not about me chipping in cash myself vs spending someone else’s money, it’s about the importance of investment, and in particular Angel and venture capital (VC) investment in making it more likely that a start-up will succeed.

There is plenty of academic research in this area (I’ve quoted from a little of it) and the research shows three things:

1. There’s a link between Angel/VC  investment and growth for start-ups. Researchers disagree on whether this is primarily linked to VCs ability to ‘pick’ winners or ‘coach’ them:

“Although prior scholarship uniformly associates VC investment with positive outcomes for startups, this relationship is predicated upon two distinct mechanisms. VCs may be able to identify, preinvestment, those startups that are particularly likely to exhibit superior future performance, thus picking winners… Alternatively, VCs may provide postinvestment management expertise and connections, thus building winners” (Baum, Silverman, 2004)

2. VC investment in start-ups is not necessarily based on evidence of prior growth. Nor, despite what VCs say, is it about the quality of the founder/s:

“Given that venture-backed startups grow faster than their non-venture backed counterparts, we examine whether this distinctive growth path is already identifiable before the first round of venture capital funding. Our results indicate that the growth path of venture and non-venture backed firms cannot be distinguished before the former companies receive their venture funding.” (Davila, Foster, Gupta, 2003)

3. VC investment “signals” quality to other investors and makes further investment more likely. VC funding tells other agents in the network that a start-up is worth supporting:

“VC firms implicitly decide the survival and death of start-ups by choosing which of them to fund… By investing or refusing to do so that signals the level of risk for each start-up and indirectly modify the risk evaluation and the behaviour of the other agents of the system.” (Ferrary, Granovetter, 2009)

Basically, if you get VC cash your tech-web start-up is more likely to attract further investment and more likely to get to market ahead of competitors.

Let’s add some figures to that .

VC funding accounted for 21% of all investment in UK firms between 2000 and 2009. However, there have been year-on-year falls in VC investment since 2008 and investment is around a third of what it was in 2000. The first quarter of this year saw a 4% drop in UK investments and, in the US, the  fall has continued into Q3.

Alongside the fall in investment, a 2010 report by Nesta identified that seed and first round funding had been hardest hit with VCs concentrating on re-investing in their existing portfolio, or focusing on later stage companies.

The report also pointed to a fall in the number of exits; an increase in the length of time taken to exit; and increase in firms needing more rounds of funding before reaching the exit stage.

There’s a nice outline of that process in Robin Klein’s post on TAG  about his involvement with Fizzback from first investment in 2005 to this year’s $80m exit sale. What you see is the close personal relationship between investor and founder and the ‘coaching’ role  Klein took on as first investor. He writes:

“Our relationship with Rob Keve, Fizzback’s founder, goes back about 15 years and we invested in IMI (Instant Market Intelligence – its former iteration) in 2005 – as part of the company’s small seed round. I well remember the 4 hours Rob and I spent driving to and from the Cotswolds every month during 2003 for the board meetings.

“Its initial vision was to address demand for rapid market research and new forms of customer insight – kind of vox pop via SMS. Selling a product to the market research community didn’t seem to me to be a place where we’d find good sized budgets. Rob had another much more appealing idea which he was running in parallel. A service to retailers and service providers which enabled consumers to provide feedback at the point of experience – in store, on the train etc – via their mobile phones – via SMS… This latter idea got me excited. I agreed to invest and join the board as Chairman.
 
“Rob and I pulled together a small group of angels – including Jonathan McKay – and what a great decision that was! Jonathan, who is a real enterprise software/services guru, took over the Chair in 2008 and helped Rob build the stellar sales team and been an invaluable guide to the business.
 
 “Step one back in 2005 was hire a small team… Operations head was Jonathan Morris (my son-in-law) – still the Operations Director of the group, often holding things together …. another reason for the soft spot for this company.”
Back in 2006, Robin and Saul Klein (I’ll return to their importance in UK tech-web) considered investing in my user-led news start-up. They didn’t in the end, but our paths cross again – Robin put me in touch with Richard Morross, at Moo, when I was still working out how to move forward on my self-publishing project, and Saul led Seedcamp and picked Sweeble as one of his ‘wildcard’ finalists in 2010.
 
To pull all this together – without investment you will run out of steam.
 
It’s hard to keep going on your own and having (the right) investor onboard does two things.
 
First, it ‘signals’ that your business is better than rest because of that VC’s reputation for ‘picking winners’. That attracts interest from press, other investors and the tech-web networks. 
 
Second, the investor brings ideas and people to the table. As ‘coaches’ they push you and help things happen faster than you could on your own.
 
Investors oil the wheels of your project’s progress.
 
Pre-investment

Pre-investment

 
 

Post-investment!

Post-investment!

 
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