Are You Obese Or Anorexic, And Does It Matter?

April 8, 2010 at 9:39 am Leave a comment

In his blog post The Case For The Fat Startup, Ben Horowitz of Andreessen Horowitz argues against the conventional, post-bubble wisdom that you have to be lean and mean to survive and prosper in the start-up race. Citing his credentials as CEO of Loudcloud/Opsware, he makes the case for outspending your competitors during the downturn.

My favorite quote: “But in a bust, having a lot of cash can be a huge competitive advantage because you can use that cash to put enormous pressure on your underfunded competitors.” Amen to that.

Fred Wilson from Union Square Ventures picked up the gauntlet and countered with The Case For The Lean Startup: “I have never, not once, been successful with an investment in a company that raised a boatload of money before it found traction and product–market-fit with its primary product.”

Which prompted The Revenge of the Fat Guy with some more clarification on why big is beautiful, and some cleaning up of common myths about that elusive product-market-fit.

The dogfight has elicited a slew of reactions throughout the blogosphere, my preferred one is making the not-so-obvious connection to Dr. Seuss’Lorax.

With so much body weight being tossed around, the questions remain: (1) who’s right and (2) what does that mean for your startup?

Who’s right?

Both, of course.

Ben Horowitz walked the walk and spent his way to success with Opsware. Arguably, this was before Opsware had found its sweet spot and dominance in the data center automation segment. Now one successful fat start-up does not a prescription for success make, and for every successful fat start-up there are plenty of failures (remember WebVan?). But the same can be said for the lean start-up. The lack of money does not predict success. Arguably, there are more dead lean start-ups than fat ones; although not necessarily by choice.

Fred Wilson has invested in about 100 web companies, and has yet to see success in doling out too much money too early.

What does it prove? If somebody gives you a boatload of money, and you spend it wisely, you can be successful; conversely, if they don’t give you so much money, but you spend it wisely, you may still be successful. Chances are, however, that you’ll build it and they won’t come.

What does that mean for your startup?

I surmise to say “it doesn’t matter”. Investors just aren’t giving out those boatloads of money anymore, so you might as well get used to the low-carb diet.

The other aspect that’s not so clear in either post is what’s good for the company and positioning the product may not be good for the founders or investors.

Boatloads of money usually come with boatloads of dilution; unless a company can prove quickly significant traction in its market. Dilution for the founders and dilution for the investors. Now it is true that 1% of McDonalds’ pie is worth more than 100% of the burger joint next door, but things are not so rosy after the second re-structuring, wash-out, and reverse split.

Boatloads of money also significantly increase the benchmark for success. Once a company burns through $30+ million, it’s hard to make everybody happy with an exit of less than $100 million. These days, most exits aren’t above $100 million, so most investors aren’t happy. What happens often enough is that with new funding, a viable strategy to get the company to an exit of $50 million is ditched in favor of a high risk, “swing-for-the-fences” strategy to get the company to the magic $1 billion exit. But this evolves from a structural issue within the venture capital industry at large, covered in two earlier posts (Bigger isn’t better Part 1 and Part 2).

Like Black Jack, doubling-down doesn’t always double your payout, but often enough leaves you with the loosing hand. Unless of course, you count the cards very, very carefully – as Ben did at Opsware.

Gunther Hofmann is a Vice President of The Brenner Group and has done extensive work in valuations, M&A, venture capital, and corporate finance with significant international experience in small firms as well as global corporations. Gunther earned a Masters Degree in Electrical Engineering and Business Administration from Darmstadt University of Technology in Germany, and was a Visiting Scholar at UC Berkeley. He is a holder of the Chartered Financial Analyst designation, and a member of the National Association of Certified Valuation Analysts. Gunther is Chairman of the Software/IT Industry Group of the German American Business Association (GABA).

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Entry filed under: Financial Advisory, Restructurings, Shareholder Services.

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