Ryan Smith knew he wanted to build a company he could grow over the long haul. So rather than race to find financiers in 2002, the co-founder and CEO of Qualtrics spent four years bootstrapping his enterprise survey provider from his dad’s basement.
That low overhead helped the start-up reach profitability almost immediately. As the company grew year by year, venture capitalists started circling, reaching a critical mass during year five. Smith says he fielded roughly 100 calls from venture capitalists and investment groups before he finally agreed to a deal in 2012.
What drew them to Qualtrics? A sound and profitable business model, according to Bryan Schreier, a partner at Sequoia Capital, who eventually succeeded, along with Accel Partners, in funding Smith to the tune of R280-million.
“[Bootstrapping longer] focuses the company on creating a healthy business model at a very early stage,” Schreier says. “It’s hard to create a viable business model five years down the road. It’s much easier if you’re focused on making money from the start.”
Qualtrics has enjoyed triple-digit growth over the past several years, reaching R200-million in revenue in 2012, with customers using its survey software to process more than 1 billion responses. Among the company’s 5 000 worldwide customers: half are Fortune 100; 1 300 colleges and universities; and 96 of the top 100 business schools.
We spoke with Smith about the many ways Qualtrics benefited from waiting to raise VC and what other ‘treps can learn from his experience.
How did waiting help?
We really wanted to nail it before we scaled it, which we did. There are some companies, like an app, where they need to go full speed on the scaling up as fast as possible.
But for most companies that have a pretty big opportunity like us, I think nailing the product and business model is critical. I think if a company doesn’t have its core figured out, it could be really difficult to find it when there’s R80-million sitting in the bank that has to be spent now.
How did you decide which VCs to partner with?
Our philosophy has been that one and one needs to equal five. Just because someone called us and said that they wanted to invest in us didn’t mean we had to stop everything and say yes. We wanted partners who were as excited about the opportunity as we were, who were excited about us, who were even excited about our location.
We were in a position to pick the firm, and we had time to build the relationship before signing an agreement. I think that many early funding scenarios are akin to getting married after a first date. Not knowing what they’re getting into is where people struggle.
What advice can you offer start-ups thinking about VC?
Ask yourself why. If you’re in a ‘scale it’ phase, I think funding can do a ton of good. If you’re in a ‘nail it’ phase, I think that’s where you see companies thrash around and a lot of them fail. If you’re thinking about taking money, talk to portfolio companies. Talk to companies who have taken funding from [VCs].
I believe that people need to bet on themselves more. What I’ve seen is that if you’re a great company, and you’ve got what it takes to take it the distance, then you’re going to have more and more opportunities the farther you go along. Trust me, they aren’t going to go away.
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Under which circumstances would you turn down VC funding?
What Funders Look For From The Funder’s Perspective
Essentially, Secha brings three key ingredients to the table.
Secha Capital is an FMCG and Agri fund that is focused on the ‘missing middle’, established but small businesses that need additional capital to assist them to reach next-level growth.
“We look for founder/market fit and product/market fit and recurring revenues,” explains Brendan Mullen, co-founder and Managing Director of Secha Capital. “We believe there are businesses that are too big for government grants, but too small for traditional funds, and that’s our focus.”
As a result, Secha addresses capital and management gaps of companies, and chooses its sectors based on research and surveys.
“We’re investment thesis driven,” explains Brendan, who contacted Danie because his team had been researching the fragmented packaged biltong sector in South Africa.
Essentially, Secha brings three key ingredients to the table:
- Growth capital: Often used as working capital, but can also be used to purchase machinery.
- Human capital support: Secha joins the team for a minimum of nine months and also sources an intern from a management consulting group or international MBA programme. The result is a skills transfer, a new perspective, additional bandwidth and operational support. “It’s often difficult for SMEs to attract the best and the brightest. We look at it like human capital arbitrage; bringing in a high-level person to really assist with projects and operations.”
- Channel access. This is the side of FMCG that requires the most persistence, and in many ways Brendan already has excellent contacts that the companies he invests in can leverage off. “It’s important to know buyers and be able to make the right connections and introductions in this business. That’s an invaluable level of support for entrepreneurs.”
For any entrepreneurs considering funding, it’s as important to consider what the investor brings to the table over and above capital — afterall, you are giving equity in your business away, a decision that only makes sense if the ultimate goal is growth.
From Secha Capital’s perspective, the first test that Stoffelberg passed was the taste test. Brendan saw the brand in a retailer and bought it. He then did some research and found a business with a one-page website and limited marketing — which meant there was an opportunity for Secha to add value.
“We were specifically looking for businesses in this sector that owned the entire processing part of the value chain. We wanted to be price makers, not price takers.”
An additional plus point was that Danie and Oom Stoffel had already secured their Halaal, HACCP and export certifications, which proved grit.
“We realised that they are the experts in meat. One of the key things they had in place was an exceptional team. Chris Bothma, who worked on the Blue Train as a head chef, is not only Stoffelberg’s chef, but he’s in charge of production, product innovation, recipes and he manages a team of 25 at head office. He’s also a shareholder in the business. Finding the right subject experts drives growth, and was a big plus point for us. If we find a business that has product/market fit and founder/market fit, we know it’s just a case of adding some other capabilities to achieve real growth.”
What funders look for
For Brendan, there are a few key areas that he considers when making an investment. First, he regularly taps into his networks to stay abreast of what’s hot and new, and what consumers are asking for. This will often lead to an investment thesis.
Next, he looks for a large TAM (total addressable market) with adjacencies. “You ideally want a large TAM in a fragmented area, with products that tend to be grudge purchases because top alternatives are not available, as well as a team or founder who really knows the industry, what’s broken, what can be fixed, and how to get recurring customers from that solution. In addition, we want to see what new value-adds you can you bring to the table.
“Stoffelberg is re-invigorating a dormant market, while another one of our investments, nativechild, is operating in a niche growth vertical within a much larger vertical and can expand from there.
“Look for opportunities in fragmented value chains, where there are no clear brands in that specific section of the market. Find that, and you can find a slice of that value.
“I also believe in founder/sector fit. Stoffelberg wouldn’t be here today if Danie and Oom Stoffel didn’t know the different players in the value chain, couldn’t anticipate pricing and didn’t understand consumer pain points. Domain expertise is huge.
Why Not Getting VC Funding Might Be Better For Your Business
Here’s why lifestyle businesses appeal to so many entrepreneurs.
When I started teaching a new venture creation elective to MBAs 15 years and over 2 000 students ago, I’d tell my student teams they each had to come up with – and develop a compelling plan for – a (theoretically) VC-backable start-up concept. Made sense, right? MBAs wanted to be part of building the Next Big Thing, and venture capital-backed start-ups had driven a massive tech boom over the prior decade – a wave I’d been lucky enough to ride.
But, it didn’t take me long to ease up on that “it’s gotta be VC-backable” requirement. Looking back, I had three reasons for that shift:
1. Start-up lessons tend to apply across the board
First, folks immersed in the action-based learning exercise of mapping out a start-up consistently reported back, after re-entering the workforce, that they were able to apply those learnings and frameworks to almost any entrepreneurial – or intrapreneurial – experience in their careers.
2. Many people find low-tech businesses more appealing
Second, a lot of teams would come up with quite interesting but low-tech startup ideas. As I discussed in my recent article, “Who Would Invest in Your Startup, and Why?,” low-tech businesses rarely represent interesting investments to VCs, primarily because of low valuation multiples (often due to limited growth upside).
3. A vanishingly small proportion of all startups raise VC financing
Finally, I looked at the numbers and realised that most startups – indeed, even most very successful start-ups – do not raise money from venture capitalists. According to statistics from the U.S. Census Bureau, 2017 saw approximately 556,000 business applications from corporations (what they call CBAs) in the U.S. (That’s only about 18 percent of all new business applications, to make sure we’re not counting sole proprietorships, two- to three-person professional services practices, and so on.) Meanwhile, Venture Monitor data from PitchBook and the National Venture Capital Association tells us that, during the same period, U.S. “first financings” from VCs (as opposed to follow-on financings) numbered 2,676, or less than one-half of 1 percent of new corporations started. Now granted, first financings from VCs will tend to occur one to three years after a company first incorporates, but the statistics year-to-year are similar enough that the proportionality doesn’t change in a meaningful way.
But, what I teach and how I teach it completely aside, my real “a-ha” has been a growing appreciation for non-VC-backable start-ups and how they can represent a genuinely appealing path for many entrepreneurs.
Let’s look at the positive side of the ledger for so-called lifestyle businesses:
Ownership and control
Raising equity financing from VCs – or, for that matter, angels – comes with a downside that few talk about: pressure to achieve a liquity event (sale of the company or IPO) within a fairly short time horizon (we’re talking three to six years, typically). Since your company needs to be pretty massive to go public, we’re really talking about pressure to sell the company. If you don’t raise equity financing, you’re in far better control of your own destiny. If you’re in a reasonably protected niche, you’ve got the luxury of time to grow at a more leisurely pace. It’s also up to you as to whether you want a board or directors and/or advisory board, and whom you want to invite to join.
Less dependency and greater chances of success
On the one hand, you’ll need to fund your lifestyle businesses through savings, credit cards, friend-and-family loans, bank lines of credit, small business loans and the like. And while it may sound sexier to load up on lots of VC rocket fuel for your start-up, as we’ve discussed, that funding path assumes you’ll be one of the select few who’s successful in attracting VC investment, and it comes with outside pressure to “go big or go home” and sell the company. So in general, you can think of well-crafted lifestyle businesses as being lower upside, but also lower risk.
Taking the lifestyle business route, you stand a higher chance of getting airborne and achieving some level of success.
More options in life
If you own and control the business, you can decide the degree to which you choose to grow it aggressively to maximise cash flow or wealth, versus taking a more casual approach. Perhaps you’ll decide to build the business to a certain plateau and then simply manage it for free cash flow that makes work an option. And, building a lifestyle business in this fashion by no means precludes eventually selling the company if you choose – or, alternatively, handing it down to your kids some day.
You can still leverage technology
Whereas a lot of lifestyle businesses are low-tech in nature, increasingly, we’re finding that even those entrepreneurs are creatively leveraging technology to successfully launch, grow and become more profitable. Social media campaigns, search-optimised websites, customer newsletters and referral networks can all play a crucial role. And behind the scenes, smart lifestyle entrepreneurs are exercising the muscle of low-cost, online tools for everything from brand management to accounting and finance, inventory control, customer relationship management, point-of-sale tools and HR management.
Building a VC-backed startup can be bracing and both personally and financially rewarding. Been there, got the t-shirt. But, nobody’s going to feel sorry for you if you get your lifestyle startup to the point where you’ve created life options such as hiring a general manager and calling in from the lake house a couple of times a week to check in.
This article was originally posted here on Entrepreneur.com.
7 Questions A Venture Capitalist Will Ask You Before Investing In Your Business
Are you ready for external financing?
It’s no secret that the number one cause of business failure is running out of cash. However, an injection of cash alone does not necessarily mean a business will be successful. Our role as a VC is to identify businesses that have a unique mix of skills and offerings that, when mixed with the right capital partner, are in the best position to succeed.
These businesses are generally run by entrepreneurs that seek to have an impact on some sector of society and have the drive, foresight and emotional intelligence needed to succeed. Finding businesses run by entrepreneurs who exhibit these qualities is a big part of our secret sauce, but equally, it’s important that we can work with, collaborate and align interests with these entrepreneurs, so that success ultimately results in both founders and investors alike realising profits and investment returns.
Understanding what VCs look for
After identifying businesses with potential, we spend a lot of time working with the entrepreneurs we’re considering investing in, asking questions like:
- Are we funding a business, an idea, a lifestyle or a big dream?
- Who are the clients, how did the business acquire them and why do they use their services?
- Does the business have a competitive advantage that’s difficult to copy?
- Can the business scale?
- And finally, is the founder and entrepreneur ready?
- Are they prepared to sell some of their company and work with external partners? Do they listen, seek and take advice?
- And when (not if) the company runs out of money, are they the first employee to forego their salary?
If you want to prepare yourself for a capital raise, these are the questions you should be asking yourself in preparation.
Right partners at the right time
Starting a business is hard. Partnering with the right investors with aligned interests is crucial and being comfortable in answering the above questions is just as important.
If answering these questions makes you uneasy in anyway, perhaps you aren’t ready for venture capital financing. Like most things in life, success comes down to people, and partnering with the right people and investors at the right time, is key. Not all entrepreneurs are comfortable working with partners. Understand what you want from a funder before you start looking for investors.
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