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Self-finance or raise money? A quandary for startups

By Ian Mount
New York Times News Service

Roman Stanek and Robert J. Moore had the same dream. The two entrepreneurs saw businesses collecting lots of data about their customers’ Web transactions and decided there could be a huge market in helping those businesses analyze the data to determine who their customers were and how best to reach them.

But while Stanek and Moore went after roughly the same market at roughly the same time, they differed in one critical aspect: how they financed their dreams. One quickly raised more than $50 million, while the other mostly self-financed, thus creating a rare opportunity to assess the difference venture capital can make and bring new perspective to an age-old debate.

When Stanek, a Czech entrepreneur, founded GoodData in San Francisco in 2007, he already had plenty of experience with venture capital. He had sold a venture-backed software development tools company, NetBeans, to Sun Microsystems in 1999 for a little more than $10 million. And in 2006, he sold Systinet, a Web-service company, to Mercury Interactive for $105 million.

After financing the first year of GoodData’s software development with several hundred thousand dollars from his Systinet sale, Stanek began to seek investors. Eventually, he brought in $53.5 million from the likes of O’Reilly AlphaTech Ventures and Andreessen Horowitz. “We spent three years building a product and we are still building big pieces. That was funded by the VCs and myself,” said Stanek, 47. “It’s like the printing business. I have to spend money on my printing machine. There’s an initial large investment, and then once you have the printing press running, it’s very predictable. So if we wanted to create a dominant large company, we didn’t have a choice.”

By contrast, before starting RJMetrics, the co-founders, Robert Moore and Jake Stein, worked as junior analysts at a New York venture capital firm, Insight Venture Partners, where they came across entrepreneurs who had built profitable businesses without a lot of capital and put off fundraising as long as possible. “What happens in those situations is those entrepreneurs do extremely well personally,” said Moore, 29.

When they started RJMetrics in late 2008, Moore and Stein invested $10,000 of their own money. Moore wrote the first version of the company’s software in his attic in Collingswood, N.J. They did not hire their first employee until 2010, and they moved to an office in Philadelphia, where costs are far less than in New York or San Francisco.

By the time they did raise some money, in early 2012, they had 100 customers and annual revenue of about $1 million. “That put us in excellent negotiating position, because we had a proof point that other companies at our stage didn’t have,” Moore said. The owners raised $1.2 million, almost all from RJMetrics customers.

The two approaches have created very different companies. RJMetrics signed its first paying customer to a rudimentary prototype just three months after it started. To build revenue, it had to hope for good word-of-mouth (which it got) because it did not have a sales staff. But bootstrapping, or self-financing, did allow the founders to keep a large percentage of the company’s equity and to avoid the distortion that can come from having money and the demanding investors who supply it.

The venture capital industry views bootstrapping in the face of a big market opportunity as false economy. John O’Farrell, a partner at Andreessen Horowitz, said that it generally took an investment of $75 million to take a software company from startup to initial public offering. “If you want to capture a big open market, you want to bring in money to grab land,” he said. “If you bootstrap, the tendency is to try to get profitable early so you don’t need to put in more money, but you end up missing a big opportunity.”

GoodData’s war chest allowed Stanek to staff up for the land grab. The company now has about 250 employees, half dedicated to the product and half charged with sales and marketing. RJMetrics, on the other hand, has 26 employees, more than half of them working in product development and only four on sales and marketing. The company’s first director of marketing started in February.

Inevitably, the companies have gravitated toward different markets. While RJMetrics has gone after small and midsize companies, GoodData has pursued Fortune 2000 clients that demand robust products and have the money to pay for them. RJMetrics had about $1 million in revenue in 2011 and about $2 million in 2012, according to Moore. Stanek declined to specify his company’s revenue, but he noted that last year GoodData signed 42 contracts that were each worth more than $100,000 a year, which would suggest an annual run rate of at least $4 million.

The founders also see their customers differently. Stanek said that multiple customers had come to GoodData from RJMetrics because RJMetrics was too small. “We have large customers who would not go to RJMetrics, who need 24/7 software, and special security, privacy and so on,” he said.

Moore, on the other hand, said his lack of financing allowed his company to pursue its vision without rushing after customers that did not fit. “Our vision is that there is as large or more opportunity in the small-to-midsize market, and we have the flexibility to pursue that and be a disruptive player,” he added, a luxury he said GoodData has not had. “To scale the business, they have to make very big investments in getting very big contracts.”

Ultimately, the question is whether it is better to hold equity or trade it for growth. Moore noted that RJMetrics’ founders and employees continued to hold more than 80 percent of the company even after taking seed financing. That meant, he said, that if RJMetrics were to sell for, say, $50 million, the founders would be set for life financially.

If GoodData were to sell for $50 million, it would be a disaster. “The personal upside for someone who owns 5 percent of a company that sells for $100 million and the person who owns 50 percent of one that sells for $10 million is the same,” Moore said. “And a lot more companies sell for $10 million than for $100 million.”

Stanek said the higher expectations he faces were worth it because he and his investors expected the company to be worth at least $1 billion. “I would not interpret it as pressure,” he said. “Life is short and we shouldn’t waste it on opportunities that aren’t worth it.” He declined to say what percentage of the company he still owns: “I am no longer the majority holder, but I have enough to keep me interested.” Last week, his company announced that it had raised $22 million in venture capital, bringing its total to $75.5 million.

Neither Stanek nor Moore sees this as a black-and-white issue. Stanek said he was a “big believer” in bootstrapping and that getting too much capital too early could be dangerous. And the RJMetrics founders recently decided that, after five years of bootstrapping, it was time to raise money to compete with GoodData and others. In May, they announced a $6.25 million investment led by a California venture firm, Trinity Ventures. “The timing was right to put the pedal to the metal,” Moore said. “Whereas in the past we’d been growing at 100 percent a year, we see a path to substantially increasing that rate.”

Like Stanek, Moore declined to specify what percentage of the company the founders retained. “It is an atypically large percentage compared to others in our position,” he said.

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