Greg Linden was one of the key developers behind Amazon’s recommendations system, which recommends books, movies, and other products to Amazon customers based on their purchase history. He subsequently went to Stanford and picked up an MBA, and in January 2004, he launched a startup named […]

Greg Linden was one of the key developers behind Amazon’s recommendations system, which recommends books, movies, and other products to Amazon customers based on their purchase history. He subsequently went to Stanford and picked up an MBA, and in January 2004, he launched a startup named Findory, which offers personalized online newspapers. It’s hard to imagine anyone more qualified to make a startup like this a success, yet Findory shut down in November 2007. In a brilliant post-mortem, Linden says his big mistake was to bootstrap his company while trying to raise funding from venture capital firms — he just couldn’t convince them to invest. He should have raised his funding from angel investors instead.

Where to raise funding is an important decision every startup founder has to make. The three viable sources at the very early stages of a company are:

  • Venture capital.
  • Angel investors. Usually wealthy individuals, but includes outfits such as Y Combinator.
  • Friends and family. Yourself, if you can afford it.

To decide which option is best for your startup, you need to understand how investors evaluate companies. There is a range of criteria, of course, but the three most important ones are team, technology and market, and angels and VCs evaluate them in different ways. Here’s how.

How Venture Capitalists Evaluate Startups

  • Market — VCs want to invest in companies that produce meaningful returns in the context of their fund size, which typically is in the hundreds of millions of dollars. To interest a VC firm, a company needs to be addressing a large market opportunity. If you cannot make a credible case that your startup idea will lead to a company with at least $100 million in revenue within 4-5 years, then a VC is not the right fit for you. It’s often OK to use consumer traction as a substitute for market opportunity; many VCs will accept a large and rapidly growing user base as sufficient proof that there is a potentially large market opportunity.
  • Team — VCs use simple pattern matching to classify teams into two buckets. A founding team is deemed “backable” if it includes one or more seasoned executives from successful or fashionable companies (such as Google) or entrepreneurs whose track record includes a least one past hit. Otherwise, the team is considered “non-backable.”
  • Technology — VCs aren’t always great at evaluating technology. To them, technology is either a risk (the team claims their technology can do X; is that really true?) or an entry barrier (is the technology hard enough to develop to prevent too many competitors from entering the market?) If your startup is developing a nontrivial technology, it helps to have someone on the team who is a recognized expert in the technology area, either as a founder or as an outside adviser.

Here’s the rule of thumb: To qualify for VC financing, you need to pass the market opportunity test and at least one of the other two tests — either you have a backable team, or you have nontrivial technology that can act as a barrier to entry.

How Angels Evaluate Startups

There are many kinds of angels, but I recommend picking only one kind: someone who has been a successful entrepreneur and has a deep interest in the market you are targeting or the technology you are developing. Here’s how angels evaluate the three investment criteria:

  • Market — It’s all right if the market is unproven, but both the team and the angel have to believe that within a few months, the company can reach a point where it can either credibly show a large market opportunity (and thus attract VC funding), or develop technology valuable enough to be acquired by an established company.
  • Team — The team needs to include someone the angel knows and respects from a prior life.
  • Technology — The technology has to be something the angel has prior expertise in and is comfortable evaluating without all the dots connected.

Here’s the angel rule of thumb: You need to pass any two out of the three tests (team/technology, technology/market, or team/market). I have funded all three of these combinations, resulting in either subsequent VC financing (e.g. Aster Data, Efficient Frontier, TheFind), or quick acquisitions (Transformic, Kaltix — both acquired by Google).

Friends and Family, or Bootstrap

This is the only option if you cannot satisfy the criteria for either VC or angel. But beware of remaining too long in “bootstrap mode.” An outside investor provides a valuable sounding board and prevents the company from becoming an echo chamber for the founder’s ideas. An angel or VC can look at things with the perspective that comes from distance. Sometimes an outside investor can force something that’s actually good for the founder’s career: Shut the company down and go do something else. That decision is very hard to make without an outside investor. My advice is to bootstrap until you can clear either the angel or the VC bar, but no longer.

But back to Greg Linden and Findory. By my reckoning, Findory passes the team and technology tests from an angel’s point of view — if you pick an angel investor who has some passion for personalization technology. But it doesn’t pass any of the VC tests. Given this, Greg should definitely have raised angel funding. My guess is that this route would likely have led to a sale of the company to one of many potential suitors: Google, Yahoo or Microsoft, among many others. Of course, hindsight is always 20-20. I have deep respect for Greg’s intellect and passion and wish him better luck in his future endeavors.

Anand Rajaraman is a co-founder of Kosmix.com and a founding partner of Cambrian Ventures. Full disclosure: He is also an investor in GigaOM.

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  1. Sramana Mitra Sunday, June 15, 2008


    I think your article is rather biased towards a self-serving point-of-view. You are an angel, and you are touting the benefits of Angel financing.

    While I agree that in certain cases Angels can add value, entrepreneurs should seriously consider doing their companies with no external financing at all. There are many ways to bootstrap, and very significant companies have been built this way. There are pros and cons, but I am afraid your article above does a rather poor job of acknowledging them.

    Regards, Sramana

  2. Anand,

    I think your assessment of the investment criteria used by VCs and angels is likely correct, however reflects “silicon valley goggles”. By that I mean you fail to mention a few important business criteria:

    1. a clear business model
    2. An executable plan for growth
    3. revenue which is yielding free cash flow

    These criteria are more important than “team” which is subjective, and “technology” which VCs typically embrace when it yields a “gee whiz” response. Many hugely successful technologies are simple, elegant, and solve a clear problem. Most “gee whiz” technologies result in entrepreneurs and their investors looking for a problem and business model. To be clear, there are exceptions, but the failure rate of VC backed companies is well documented. Only a handful are truly profitable as was noted by the venture capital industry association a few months ago.

    Private equity firms apply the above criteria irrespective of “team” and “technology”, but do so when a targeted business has clearly proven a large market opportunity. This likely explains why private equity firms have a much higher success rate with their investments as the investment criteria yields a more efficient use of capital.

    I think your assessment is a GREAT primer if an entrepreneur (or team) is following the valley dream. However, if the entrepreneurs plan and build a solid business with good fundamentals, investment capital (VC or otherwise) should be an option for achieving scale more quickly, but the business should be able to stand on its’ own feet.

  3. Data Digga » Funding options – angels & vc’s Sunday, June 15, 2008
  4. Nice article

  5. Neyma Jahansooz Sunday, June 15, 2008

    I agree with both the author and somewhat commenter’s #1 and #2.

    With regards to SV goggles – being somewhat on the outside and maybe a bit old fashion, I am building a company that will do lots of nice 2.0/social stuff, but is also designed to stand on its own two feet from the start.

    Meaning that we may or may not take VC funding at some point, but the VC funding will be for the purpose of scaling that which is already sucessfull and somewhat proven on a smaller scale. And for what we are doing – you dont need millions of $$$ to do that – unless you really like to spend $$$. (which many in the valley do)

    I know it has become the de-facto SV standard to do it the other way – but that way just doesn’t smell right and I would myself be wary of taking money from any VC firm that has a history of throwing large amounts of $$ in places that it is not necessary as it tells me something about their decision making process who could become a liability for myself later in the future.

    Steps to true success

    1. build product – if you take money – spend it like it is your own.
    2. get product active with user-base – prove that it can work and people like it. To get to this point – should take as little money as needed. Think like each $$ you spend is coming out of your children’s mouths so it will all be spent wisely
    3. After product is proven – then further funding may be an option for the purposes of ‘Scaling’ and expansion.

    If these 3 steps are correctly met, then it will not be a desperate lunge to gather VC, rather they will be knocking on your door as you seem more like a sure bet.

    Setting up the playing field in such a way is the correct and robust way to lasting and consistent success.

  6. Anand Rajaraman Sunday, June 15, 2008

    Sramana: I have nothing against bootstrapping. I’m just recounting my personal experience from over ten years of being in, funding, and advising startups. Your mileage may vary.

    As Curtis points out, my learnings are all from a Valley perspective. So they apply to companies that want to either go public or be acquired – the traditional exit options for Valey companies. For companies that just want a steady stream of revenue and profits, the bootstrapping model is just fine. There’s also more discussion in the Comments section of my blog on this topic: http://anand.typepad.com/datawocky/2008/06/angel-vc-or-bootstrap.html

  7. As an entrepreneur who successfully boostrapped a company and ended up selling it to Cisco, I can say that it was the hardest thing I have ever done. Do not attempt it unless you either have a pile of cash to fund it yourself, or you enjoy the taste of Ramen noodles. If you enjoy a stress-free life then raising capital is the route for you. If you don’t mind sacrificing in order for more money down the road, bootstrap.

  8. Berislav Lopac Sunday, June 15, 2008


    A VC-backed company doesn’t have to be profitable to be successful; it’s more than enough if it’s acquired along the way. And in the changing world of low-cost startups, Web and software IPOs have become a rare beast indeed.

  9. hogwash. you bootstrap “forever” or until VCs pitch you if you want full/majority ownership of a *profitable* biz model (eg jobs & wozniak w/ apple or b.gates w/ msft). if you don’t care about your “baby” and wanna sell out eventually, esp. if you have no immediate profit model, by definition you can’t bootstrap, then you pitch VCs in return for ownership. and if you can’t get no VC’s, you bridge/pray while still pitching VCs by getting dummies…er angels…to invest in your thing that you intend to sell off anyways. it’s still buy low, sell high, folks. think about it.

  10. Anand Rajaraman Sunday, June 15, 2008

    The problem is, not every business *can* be bootstrapped. The biggest successes (Google, Yahoo, YouTube, …) — none of these business could be bootstrapped, because they required investments in engineering, hardware, and marketing beyond the ability of a founder *before* they became profitable. If all you want to do is bootstrap, you limit yourself to a certain kind of idea — those that can be profitable with a small investment of time and capital. If your business fits in that category, you certainly cana nd should bootstrap. Unfortunately, many businesses don’t fit that model.

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