The Missing Middle of Funding Tech Companies
05 Dec 2022 - Thomas Depierre
Tech companies that make money for their investors seem to mostly… not exist. And the reason for that is that we have no financial instrument to fund them.
In this post i will review the existing financial instruments usually offered to finance the creation of a new firm. Try to show you these instruments do not work for tech company that want to make money for their investors. And leave you at that.
If you like this and would like it in talk form in a conference you organise, feel free to contact me.TODO, insert mailto I would love to make a talk version of this post.
What are you on ?
I have been mulling this one over for months. I do not feel like i am the best placed to talk about this. I am not from the financial or capital industry. I have no degree in Business. I am definitely not an economist. And the tech company i founded got no investment.
Maybe i am just am ignorant spouting my own frustration and refusing to accept i failed.
Except… i am not the only one. In the less obvious corners of the tech investment industry insiders do talk about it. But also hidden in plain sight in the profit report and analysis from insiders, you can see these realities talked about. TODO insert footnotes here
Note that i will not try to explain why these financial instruments are not adapted. Nor why we do not have better one. I have ideas of course. But i am not at the point i feel they are developed enough to make sense in this format.
What are you smoking, there have never been more VC funding
True! And none of it make money!
Let’s review the VC view of investment in tech. Every few years you go get investors, Limited Partners or LPs, to give you money. A few millions, a few dozen millions, a billion or two if you are Mayasoshi Son. Then you find a dozen or two new coming startup. Give them money. And hope one of them survive.
You see, in the VC view of tech, every single startup fail. None of them can bring money. But at the same time, in their view, tech is an eldorado. If your company make profit, it will be a gazillion amount if profit forever. There is no middle ground.
In this format well. Counting your losses make no sense. You just keep playing the lottery until you get a winning ticket and tada. You covered all your losses. Losing… do not matter.
Great right? That aligns with what we know about startup. Nearly all of them fail. Right? Right?
Nope. The indications that this model of tech products return on investment and profitability is wrong are multiple.
Let start with startup failure numbers. Is it because startup are fundamentally hard… or because we make them do something that is fundamentally impossible? Is it a fundamental truth of tech that returns have to be a power law? Or is it the result of survivor ship bias ?
Well ok. Maybe tech startup do not have to be so hard. But at least the lottery aspect is true right ? Look at all these massive exits! Except less than 5% of VC funds every year return any kind of alpha above an index market benchmark. 95% of the money spent by LP is lost forever. And the 5% that succeed definitely do not do the 20x needed to compensate this.
Who cares if LPs do not get money back! At least we have profitable firms allowing us to get all these useful tech ! I mean. We do right ? Well…. actually… nearly none of them have ever made a profit. The Uber case is obviously the elephant in the room, but i personally prefer to use example closest to tech people life.
Let’s look at New Relic. New Relic is a monitoring company for tech systems. Basically if your complex computer system fails it helps you know it did and it helps you find out what was wrong. The defining characteristic of New Relic that every tech person will tell you if you mention it is that “it is far far too expensive”. This is a general accepted truth of the tech world.
Despite this. They never posted. a. dime. of. profit. Zilch. And they are not a special case. Hashicorp? Nada. Datadog? Niet. Gitlab? Ahahah. I could keep going.
Once we take all of that into account, it seems that VC mostly fund unprofitable businesses and lose their investors money. If what we want is to fund profitable tech that enrich capital, i am sorry Mario. But the princess is in another castle.
Historically, another way to fund your fledging business is to go ask the bank for a business loan. This is a well known and established solution. After all, how do you think your plumber bought their work truck/van.
Except tech business have a fundamental problem. Despite what the accounting norms tell us, software is mostly… an OpEx heavy business. Most of the code written by your salaried dev cannot be run without constant work by said devs. Written code is not an asset and both the market and banks recognize that reality.
What does that mean for a bank? Well that if you start a tech business… there is no asset to recover in a bankruptcy. This is were the VC model of tech failure and success is not wrong. Tech startup that fails are a write off.
And that means a loan to a tech startup is a massive risk for a bank. So they mostly… don’t do it. There are ways around that but let be honest it is mostly not going to happen
There are all kind of program by government dedicated to startup. They are usually not applicable to you, especially if you operate a remote first business, are not part of am already large firm or are starting off in a rural place.
If you have access to them, enjoy and go forth. But they are usually not accessible as a first pre seed or seed round
VC and peddlers of “entrepreneur lifestyle” love this one. Love Money is basically all the money your loved one will invest into your company early on because they want you to succeed.
Outside of the obvious problem of pressure, there is also the problem of accessibility, after all if you need funding it is usually because you are not born in a rich enough family to care.
And even more, there is also the reality that if there is no financial instrument to fund you other than the bank of mom and dad, the financial system definitely do not have an instrument to finance you.
Which is also why i will not be covering bootstrapping.
I don’t know. I mean we know tech startup can be wildly profitable. Otherwise noone would bootstrap. And that investing based on a profitability base work. There are niche product, mostly catering the bootstrapping community, that succeed widely in term of return on investment. With lower risk than the VCs.
We also know that the current VC funding instrument produce mostly broken and not adapted products.
It seems there is a glaring missing middle financial instrument. I of course did not ponder what it could be, why it does not exist or any solutions. This post is about acknowledging the problem.
So. What did i miss? Feel free to comment or @me on twitter or by email, both in the footer.