June 9, 2010
Recently there have been a few posts about growth through funding and growth through organic means. Tony Hsieh from Zappos told his tale of woe about the expectations of VC’s in terms of good exits. On the other hand, Sridhar Vembu, Founder of Zoho (disclosure – Zoho is exclusive sponsor of CloudAve) wrote an excellent counterpoint – one that spoke of freedom, sustainability, social conscience and the like.
Reflecting on all of this, Dennis Howlett looked at two companies in the SaaS accounting space, Xero and KashFlow and reflected upon their particular approaches towards funding and growth. He contrasts their two approaches thus:
Xero on the other hand has had a deliberate policy of burning its way through capital in order to achieve market position. So far, it has been careful to select investors that understand its core market and is under no pressure to return a profit. Kashflow meanwhile only took one tranche of investment from Lord Young in the early days and has worked its way towards profitability… Making profit from software isn’t hard, making sustainable profit is much tougher. Evidence to date suggests Xero’s strategy is winning. It is adding customers at a much faster rate than Kashflow. That’s because it has the money to get out and market in ways that Kashflow cannot. In turn that means Xero has a better chance to be viewed as sustainable even while it continues to burn cash. That has an invisible but braking effect on Kashflow.
Unfortunately I have to disagree with Dennis’ use of the word sustainable. The Oxford dictionary defines sustainable as:
(of industry, development, or agriculture) avoiding depletion of natural resources
Or in other words, having the ability to self-perpetuate without the input of extra resources. The problem here is that Dennis’ contention that Xero is adding users at a much faster rate than Kashflow, while true, assumes a limitless market. This is of course not the case and there is no certainty as to how big the SaaS accounting market will prove to be (at least within the timescale that a startup’s burn rate allows for). This being the case, it’s a smart move to have a cost structure that doesn’t require a massive customer base to break even. Or in other words – if company A needs (for example) 100000 paying customers to break even, that’s always going to be harder in a new market than for company B who can break even with 20000 customers.
Let’s be clear here – Kashflow is profitable – today. There’s nothing more sustainable than a company that is turning profits. The braking effects and questions around sustainability can be dismissed when seen in the light of the most important line of all – the bottom line. I talked to Duane about their profitability and his reply was:
We’ve been profitable for years. Seriously. Not huge amounts, but stilll in profit. 30k last year, 9k the year before. Less the year before that. I thought the move to London and hiring an expensive CTO would push us into the red, so I got Lord Young to underwrite it. But in the event we managed to do it out of cashflow and didn’t need to take any more money from him for it.
Having ruminated on all of this, I put some more questions to Duane - I asked him why he started off as a bootstrapped business.
At first, bootstrapping wasn’t a choice – it was the only option. In the early days I had no chance of raising money from anywhere other than a small start-up loan from the Princes Trust. I got comfortable early on having a business that could only spend the money it made. I think this instilled good discipline and forced us to be very efficient. It’d be very easy to burn through a lot of money very quickly and get little return.
Since then, I’m sure we could have raised VC funding if we’d wanted to. We’ve had a lot of interest from VC firms from both sides of the pond. But I suspect they’d be a lot of time, effort and money spent on getting a deal done if we did want to. And once they’re on board, we’re then committed to the growth plan that we sold them. If something changes in the market, or a new and better path presents itself then it’d be difficult to change route quickly, or to change route at all without a lengthy justification. So not having external investors to answer to keeps us very flexible and agile.
Duane then reflected on something raised by Tony Hsieh from Zappos – the quality of life aspects of bootstrapping. This is an aspect that is often overlooked when determining a funding route – and the fact that it’s overlooked is a real shame. As Duane said:
One of the big reasons for us still having not taken VC money is my own personal quality of life. I really enjoy what we’re doing at KashFlow at the moment. It’s fun, it’s interesting, I have a lot of very good advisors around me that I’m learning a lot from. My chairman keeps me on a pretty long leash. Although we talk a couple of times a week and have board meetings with my other directors every month – he never throws his weight around or dictates what I should or shouldn’t be doing. Giving up a seat on the board to a VC would dramatically change the dynamic that we currently have – a dynamic that works for me personally and for the growth of the company.
I don’t doubt that with VC backing I’d make a lot more money personally and make it a lot quicker than I would with the path I’ve chosen. But I’d be miserable. I wouldn’t be enjoying what I’m doing if I’m being restricted in how I run the business. This would have a knock-on effect on the rest of the company and on my personal life and hence my wife and young daughters. Financially I do well enough from the company so that we have a comfortable life and I’m in no rush to look for an exit any time soon.
As a side note, I think it’d be short-sighted of me to give up any equity now considering the growth curve we’re on. Although that is perhaps a naive way to look at it.
Cutting to the chase, and in an attempt to answer the questions raised by Dennis, I asked Duane whether he believes it possible to scale without more external funding?
We can scale without external funding, but not as quickly as some competitors that have taken in a lot of cash. But I’d rather take a “slow and steady” approach to building the business rather than getting addicted to and reliant upon external money. No doubt this will be at the expense of being the market leader in the short term, but I think that’s a price worth paying to have a company with solid foundations that stands on its own two feet. There wa
s a point last year when I thou
ght we might take money to take things to the next level, but it turned out we could do what we needed to just from cashflow. We’re scaling already. Customer numbers are growing quickly, the infrastructure is being grown, the size of the team is growing too. All whilst staying cash positive.
Which gives something of an answer to the “sustainability conundrum” raised by Dennis.
So what of the credibility that funding brings. I asked Duane whether he needed the credibility that high-flying, and deep pocketed investors can bring?
I think if we didn’t have a “Lord on the board” then the credibility factor could be a strong pull towards taking VC money. Credibility is very important in the market we’re in. I think that was one of the big deciding factors behind Rod Drury’s decision to have Xero as a PLC from day one. Initially we were certainly more in need of adding credibility to the company than other start-ups would have been just due to my own colourful past. But being chaired by the ex Secretary of State for Trade and Industry and ex Chairman of Cable and Wireless brings a hell of a lot of credibility in the UK market. We now also have a long and proven track record of trading and delivering on our promises. Coupled with a relatively high profile it to some degree diminishes the need to add credibility in other ways.
Which is interesting an does concur somewhat with what Dennis says. I contend however, as I pointed out in a recent post, that there are ways of building credibility cheaply. More on that later.
So where does that leave us? I spend a lot of time talking to startups and there are no hard and fast rules that apply to them all. What I would say is that if there is the opportunity to build a profitable business, while maintaining control and enjoying a reasonable quality of life and all while bootstrapping, then this is the ideal route to take. If there are market forces, competitive issues or limited lifespan pressures that mean that a funding route is the only way to go, then so be it.