There’s an old line in journalism that the only thing they promise you when you start as a writer is long hours, low pay, and a good obituary when you die.

So it’s no surprise that the GigaOm implosion has generated a mountain of sentiment, caterwauling, and hand wringing.

What I haven't seen, however, is an analysis that gets to the heart of what went wrong.

Here’s what happened: They took VC. 

It’s really that simple.

I’ve seen it up close a bunch of times. I don't know Om Malik, but I know how businesses interact with VC, and it works like this: A person goes to a VC and sells a vision of a zillion-dollar company. The VCs buy the vision, and invest.

Then one of two things will happen:

  1. The vision will come true, the company will become worth a zillion dollars, and everyone will be rich and happy. We all know all about these companies. The odds of that happening would make a back-alley craps game operator blush.
  2. Things don’t work out, and the company folds.

We are hearing a lot about GigaOm because the people who do most of the writing about such things know all about that site, or they are friends with the founder or the reporters. But the reality is that this happens all the time.

The incomparable Danny Sullivan pointed out that the best strategy to build good companies is to do so one piece at a time. But he’s polite, so he didn’t say what needs to be said about why it is that VC-funded companies are actually in a worse position to build strong businesses.

I’m not so polite, so I’ll say it: VCs force real companies to make dumb decisions. 

Let’s break this down using big, round numbers:

Let’s say that a company has taken a total of $40 million in three rounds, and all together after those three rounds the investors own 80 percent of the company. Let’s also say that there’s one VC with a total investment of $10 million, or 25 percent of the total invested in the company.

VCs are pretty open about the fact that they typically only have one “hit” out of 10 investments. So if that VC has $100 million invested in 10 businesses at $10 million each, they are counting on one of those to return all the money invested, and then make a profit. That means they will need their $10 million in one company to turn into $200 million for a 2X return for that fund. Over the 10 years of a fund, that’s not even all that great.

So… we have a VC who has $10 million of the $40 million invested in a company. The VC’s share of the company, then, is about 20 percent, (25 percent of 80 percent.)

That means the company will need to sell or get an IPO valuation of $1 billion for the VC to get the result he is looking for. At $1 billion, the VCs all together would get 80 percent or $800 million. The VC who had 25 percent of that is gets $200 million, which is what he needs to get that 2X (meh) return for the fund.

From zero to $1 billion in less than 10 years.

What’s the upshot of all that math?

A VC once (at a bar) told me that he has 10 companies in his portfolio. He said that he is quite sure that at least half of them are much worse off"Š because of"Š his investments in them.

Let that soak in for a minute. The companies he’s betting on are doing worse because he put the money in. How does that happen? It’s not by accident; it’s because of the ways in which that VC is pushing them. He insists that they take actions that he knows will probably kill the company on the chance that those actions will help the company turn into something huge.

Why?

Look again at the math. If a company is trucking along nicely, growing at a predictable rate, making customers happy, but is not on track to be a billion-dollar company within the years left in that fund, to the VC that situation is the same as an absolute failure. 

So, the VC will push the company to do daring stuff. Crazy stuff. Shoot-for-the-moon stuff. 

The exact stuff that makes a company worse off takes the company leaders off the goal of making customers and employees happy and instead makes them focus on shooting for the moon.

In short, VC makes companies dumb dumb dumb.

 

The picture above this post shows one cow that’s different from all the other cows. It’s standing on a bed of sawdust, and has a lot of people milling about it. The other cows are just standing in the mud.

Journalists pay attention to the one who gets the special treatment, just because it’s special. That’s why there’s so much validation for raising money.

But when you are eating a hamburger, would you be able to tell the difference between the one who was standing in the sawdust, and the others just standing in the mud?

As a CEO, I’m often asked what kind of fundraising I’ve done to grow my company to seven employees, 5,000 writers, and perhaps the most successful company anywhere for small businesses to buy blog posts. My answer is always the same: We’re customer funded. Customers are the best investors. They don’t have crazy term sheets. They don’t make you go to meetings. They don’t make you dumb.

Customers only demand excellence. And that challenge is one all entrepreneurs should enjoy rising up to every day. 

Published on: Mar 12, 2015