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In These Tough Times, The Lean Operator Gets the Funding

By Carol Tice

Time was, entrepreneurs approached private funders with little more than a gleam of an idea. The funders gave them money to go create a prototype, and more money to test-market it, and then more money to finally roll it out.

Boy, how times change. Advances in technology have revolutionized the point at which big funders often get involved in a startup. In talking with venture capitalists over the past year, I increasingly hear a theme: investors expect some serious bootstrapping before they get involved. 

The cost of developing technology has come down so much that most investors are looking for a company that's already created that prototype and done some testing. Also, the rise of cheap outsourcing and the ability to build virtual teams through Internet-based technology means startups can get the skills they need for less. Many startups today are totally virtual, with everyone working from home, so they're saving on office rent, too.

With social media, it's basically free to reach out and find prospects. If a company hasn't done that already on their own dime, investors tend to be skeptical, and wonder why. Companies that are hiring big staffs too early and creating big overhead that sucks their cash down don't appeal to funders right now.

Major investors want to talk to real, live customers about how they're using a company's product or service. Do they love it? Would they recommend it? If it's a monthly-subscription model, are they renewing? They want hard facts at their fingertips.

I was speaking recently with prominent venture capitalist Jeffrey Bussgang about the trend to favoring lean operators. He's put out a new book about the funding world, Mastering the VC Game – A Venture Capital Insider Reveals How to Get From Start-up to IPO on Your Terms (Portfolio May 2010).

"It's especially true for Internet companies," Bussgang says of the lean-operations trend. "In my book, I talk about how the game of building startups is like running science experiments. It used to be a lot more costly to conduct experiments – it used to cost $5 million to figure out if you had a software product you could ship and anyone might buy. Today it costs $1 million.

"So you want lean startups going until they find that fit, and they should really scale only when they're ready. VCs are more interested in helping you market what you've developed already."

With big VCs getting pickier and wanting companies to be more developed before the investment comes on, it leaves more opportunity for small investors to get in on the ground floor. Companies still need a small amount of cash while they create that prototype, and need investors willing to take a chance at that riskier stage. That's the opening for angel and private-equity investors in the marketplace.

About the Author:
Carol Tice has written for Entrepreneur, BNET, The Seattle Times, The Puget Sound Business Journal and many other publications.