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Venture Capital, Angels or Bootstrap?

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 and a founding partner of Cambrian Ventures. Full disclosure: He is also an investor in GigaOM.

37 Responses to “Venture Capital, Angels or Bootstrap?”

  1. No, the market for finding and matching private capital is not efficient, and can often be ineffective. The Speed Venture Summit(TM), New England’s leading speed-pitching event, is developed and designed by investors to overcome these challenges. Next scheduled for October 28, 2009, SVS features founders and other execs privately pitching their growth stories in person to reps from six of the region’s top private capital investors, including angel groups and seed- and early-stage VCs. For more information, please visit:

  2. Krishneil

    There were no IPO’s in Silicon Valley in the last business quarter.

    In a future post, could you discuss what ramifications this might have for startups and ventures looking for funding.

  3. Patrick

    The article raises some good points, but if you’re a founder who’s goal isn’t just to sell the company later on or go public, then VC and angel investing is not a good choice.

    One of the main reasons I’m in the process of launching a startup is to express my ideas, profit from them… and NOT WORK FOR ANYONE ELSE. When a VC or angel enters the picture, they provide the money, so for the most part, they make the ultimate decisions. And if you truly enjoy your business, you don’t want to see control switched to an acquiring company or outside shareholders.

    “My advice is to bootstrap until you can clear either the angel or the VC bar, but no longer.”

    I would disagree with that statement. My advice would be to bootstrap until your company turns a profit (which should be a lot quicker than any of the other two options). Of course you would do that responsibly and know when it’s not financially smart to continue to personally finance a failing entity.

    In all, both VC and Angel investing are great alternatives, but for someone like me who is passionate about what I do, and likes having control of something i created, and not the intention to just create something and sell it, bootstrapping has more positives than negatives.

    Maybe I’m a traditionalist, but if I need money for financing, my first option will be bank loan/credit card, and just hire smart people to move my company in the right direction without giving up too much control.

  4. Jenkins: Unfortunately, the market for early-stage funding is not as efficient as you believe. Venture capitalists (or angels, or anyone else for that matter) are not always able to predict which ideas lead to successful companies. This means many successful ideas never get funded. It also means that many bad ideas do get funded. The earlier the stage of the company, the more inefficient the market. Which is why it’s useful for entrepreneurs to know who to approach for funding: angels or VCs.

    If your startup doesn’t need funding, and you can bootstrap your way to success, more power to you.

  5. Looking forward to a time when we can add the 4th category, peer-sourcing your startup. I expect the three above to stay, but a few new ways to start appearing that will offer entrepreneurs alternatives to smarts in business advice and money to get started.

  6. Great post!

    Unfortunately, I don’t have an MBA from Stanford, my team doesn’t include any seasoned executives from successful or fashionable companies (such as Google), I don’t know any reincarnated angels (that know and respect me from a prior life). I’m not aware of the existence of an angel that has prior expertise in in my field and is comfortable evaluating much of anything involving any risk – with or without all the dots connected.

    And even more unfortunately (perhaps this is where my lack of an MBA from Stanford is letting me down), I thought a “business” was supposed to generate a steady stream of revenue and profits.

    And, crap, I never imagined that it would be hard, or take any effort on my part to start a business.

    We’ll, I’m an idiot, so as soon as I burn the SUV and sell the kids to the onion farm down the street, I’ll just go put a bullet in my head.

  7. jenkins


    Respectfully, I think you’re very wrong and misguided. VC dollars try to flow to the opportunities that show the most promise for Return on Capital. Once in a while a great project is passed over purely due to terms, meaning the founder has impossible expectations or something, but most of the time good projects get funded on some level. Findory was not something worthy of funding because it didn’t have a chance of returning a good return. Period.

    You’re buying into the spin my friend.

  8. Anand,

    For clarity, I must add that VC or angel funded businesses have no greater or less chance of an exit versus a bootstrapped business. It seems that you’ve implied a likely increase in an exit if outside funding is received. I’ve yet to see any data which supports this assertion, if indeed you are implying this point.

    As an aside, I must point out that capital intensive technology businesses (examples include chip design/production, biotech, and telecom infrastructure) typically require outside capital at startup stage in order to reach proof of concept. I think this is the origin of the valley’s VC beginnings.

    Great thread overall.

  9. Jenkins: I don’t agree. Findory was trying to build a personalized news service. Executed and marketed well, this is a good business opportunity, especially given the fragmentation of information across millions of blogs and niche news sites. Unfortunately they couldn’t make the investments needed to make that happen.

  10. Batman is right on the money. Of start-ups founded in the 2000’s, only one billionaire has emerged, and even that is based on a speculative valuation: Mark Zuckerberg. Not even Beniof stacks a full billion. This is due to to the fact that venture capital and angel money is too pervasive and there are far too many entrepreneurs in general. Most founders are not entrepreneurs from a risk perspective because they refuse to invest even a little bit on their own. And even when they do, it’s done to buy time for more financing, not to scale to revenues. Once outside financing is a critical element of growth at the early-stage, it’s basically a pension fund’s manager using firemen and teacher’s money to fund MBA’s managing venture funds to funding “seasoned” founding teams that don’t want to accept any real financial risk. It’s a good process, but it has become so institutionalized, that the chance of billionaires emerging from this structure is now non-existent.

  11. jenkins

    This is simply not credible. The reason why Findory failed was because the idea was terrible and small. There is no need forno on that service. It was a geek tool that only its founder cared about. This is why no one wanted to invest. Bootstrapping had nothing to do with it.

  12. Given my experience in consulting with many early stage technology companines in the Bay Area, I would say that the majority of companies who raise a VC round of financing, had previouly raised money from “smart” angel investors. This doesn’t mean you can’t boostrap the company to a VC round, but if you do, you need to be swift in getting to a market/product. The question really comes down to timing the market, so if you can complete the product/service quickly by boostrapping that is great.

  13. Anand,

    Wonderful article. We’re actually in the process of weighing all the pro’s/con’s as listed above. If you’re looking to invest in an innovative new concept with great partnership opportunities, don’t be shy.

    We’d love to talk…

  14. First, not all angels are created equal. If you do raise capital, make sure your source is the right fit, and is in it for the long haul. An part time angel who is doing it as a hobby can be a a significant risk to your venture, and you may be left stranded with no additional funding opportunities. Second, if you do raise money, be sure its enough to get you to the next milestone. Otherwise, you may have to return to the well before you have actually done anything, which can be very expensive.

  15. It sounds like the primary argument for raising financing is that it brings some experience to the company. Giving up equity in return for experience seems like a very expensive way to raise financing.

    For Aroxo we’ve set up our own advisory board made up of execs from internet majors, start-ups and traditional businesses.

  16. 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.

  17. batman22

    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.

  18. Curtis,

    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.

  19. 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.

  20. 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:

  21. 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.

  22. 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.

  23. Anand,

    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