This post is written by Serguei Beloussov, PhD, is a Senior Founding Partner at Runa Capital, a founder of a virtualization technology company Parallels. Follow him on twitter.
Money can be different; it can be “smart” and “not so smart”. When seeding or growing a start-up, it’s critical to attract the “right” investors with “smart” money. While this may fly in the face of conventional wisdom – embrace any investors willing to bet on your business model – entrepreneurs must really pause and consider if they are making an equally shrewd bet on the investor, too.
One of the cases in my personal business carer: a prominent but conventional investor was introduced to me at a certain point about investing in Parallels, a profitable software company that we founded in 2000; his businesses bringing in steady cash flow, this big shot was hunting around for new opportunities. While due to the internal re-structuring we somewhat urgently needed to find a buyer for some small % of Parallels stock, working with this guy was doomed from the get go. Why? He truly didn’t understand the software business model. “Let’s compare your business with a hotel,” he proposed. “How can you ask for 20x EBITDA valuation, when I could only get 5x EBITDA for my investment in a hotel?” Although it seemed rather obvious – hotels have lower margins, higher fixed costs, limited scalability with any expansion requiring high capital costs – the software model just wasn’t an intuitive recipe for his investment cook book. His flawed comparison set off alarm bells. Ultimately, we couldn’t reach an agreement, as I realized that while this person could bring money to the company, I would have had to constantly explain and spoon-feed every aspect of the business to him, whenever there would be a change, which is in the fast growth business is actually almost constantly, and so the trade-offs were not worth the effort.
By viewing money as the most important thing for their business, startups often bring themselves into a corner. Entrepreneurs must place a premium on the quality of the investor(s) and understand why a smaller amount of money can serve companies better, in most cases, than big money with little or no relevant business expertise. Parallels has grown into a worldwide leader in cloud services enablement and desktop virtualization software, due in part to the presence of relevant investors who have helped and continue to its rapid and profitable growth with their critical expertise and guidance.
There is an important advantage to an association with superior investors: It gives you the ability to recruit the best employees, partners and suppliers, as well as best future investors. Potential partners and top-level employees don’t have the resources to conduct the sort of due diligence executed by relevant VCs or private equity investors. If your early round of funding comes from top-notch sources, this signals to potential partners and sought-after employees that there’s a good deal of knowledgable confidence in your company’s business model and potential for future success.
At Parallels, for example, we’ve been able to attract an impressive roster of top talent, including many members of our leadership team, who have deep and relevant industry experience from the likes of Microsoft, Alcatel-Lucent, General Electric, McKinsey & Company, Novell, Symantec, VMware, Monster.com and Yahoo! I attribute a good deal of our recruiting success to the message that is sent by the involvement of the top investors in Parallels – including Bessemer Venture Partners and Intel Capital.
Because I believe in the model of both “investor and incubator/accelerator” I put my time and resources into a growth and early stage VC firm, Runa Capital. Runa takes a very active part in the daily life of a startup, including consultation and hands on help, if needed, on operations, engineering, business development, strategy and planning the liquidity event of next round of financing. Runa makes introductions to key potential partners in a startup’s relevant market, assisting with talent recruitment, providing guidance on obtaining patents and protecting IP, and even marketing advice and searching for future investors.
For example: Jelastic, from Zhitomir, Ukraine, is an emerging player in the cloud computing; they provide a next-gen Java (and soon PHP and Ruby) development-as-service platform which can run and scale any Java application without the need to deploy and administer the complicated infrastructure. Runa Capital, introduced Jelastic to many of the world’s largest hosting companies when the company had virtually no name or technology recognition. And most of them responded by eagerly bringing Jelastic into their data centers. This cooperation with Runa resulted in Jelastic signing its first 15,000 customers. If Runa hadn’t provided Jelastic with counsel and made the introductions to the who’s who of the hosting world, Jelastic’s progress would have been much delayed (or, perhaps, never taken off).
The net-net is that quality costs money. And quality money costs more, too. Entrepreneurs and their start-ups must be prepared to give up more equity if they expect to have a quality team backing them up. Don’t be dumb. How much your share of the company could be worth in five years is much more important than the shares you barter away to investors. And, regardless of what you give up, make sure what else you get in return from your investors is just as valuable to your future success as is the check they hand you.