Imagine us, deciding to start a software company, without any experience, resources, or a golden idea. I told this story at LeanCoffeeTO a few weeks back, and since it was well-received, I'd like to share it with you here. Read more...
For the sake of this article, let's say the objective of a startup is to build a piece of software that can make a lot of money, or attract a lot of users. And let's also assume that building a piece of software that can accomplish these goals needs significant time and energy to slip into profitability. Finding a way to sustain the company until that time arrives is just a reality of doing business, and that sustenance comes in many forms. I believe this is the defining question for any startup, and the answer you choose will influence the startup you build.
I also believe that the dominant models of startup funding are either unrealistic, or adverse to the interests of its founders. Of course, there are benefits and disadvantages to every option, but our decision to pursue a different business model has given us a lot of flexibility and protection that many other funding models were not designed to provide.
If Bootstrapping was realistic, it would be the best option available. Unfortunately, it requires that you know what you’re doing. There are two ways to bootstrap your company: save a lot of money and stock up on top ramen, or keep doing client work while you build your product on the side.
If I had enough money saved to keep a company going for a few years, I would already be rich. But there's another problem: working for free is demoralizing for a company. I want to pay my team, my partner, and be paid myself. Earning your keep makes you work like a champ.
Doing client work to pay the bills while you build "your product" isn’t impossible, but it’s unlikely to happen. We tried to do it, and it didn't work. It's impossible to give your product the attention it deserves while you're devoting your most creative hours to your client's projects. Building and selling software is a full time job.
I've met countless smart people who have been dreaming of building their own piece of software for years, and I hear the same refrain at every meetup. "This site we're building out for client X is taking up all of our time, but it's the last one, I promise." Maybe if you didn't lease that two-thousand square foot office and start that family you'd be able to cut the strings a bit earlier.
Investors and Incubators
There is absolutely no shortage of incubators (even in Toronto) and investors waiting to get their hands on young talented minds and the ideas that rest inside them. A quick look at how some of these groups looks at startups is enough to turn me off. And while some of them are pretty cool, they're hard to get into, especially if you don't have some interesting credentials. But for people like us, without an understanding of customer development or a truly golden idea, we were out of luck.
I see two major ramifications of seeking outside investment to facilitate the development of a startup. The first is that you’re now accountable to a board rather than to your customers. Even prominent investors are lamenting about the utter lack of any professional standards, resulting in bad board members leaving a trail of broken companies behind them. More importantly though, working in a pressurized environment must make it hard to take chances, learn through discovery, and pursue many experiments.
More importantly, outside investment means giving away a piece of your company. This is your baby, the thing you’ve nurtured and cared for and shaped. Would you give away a piece of your real-life baby to make it successful later in life?
The Partnership Model
In the summer of 2008, Cameron and I were hired as part of a rag-tag freelance team that was cobbled together to build a web app. The project came about because a successful offline company that had been doing live event training in the automotive industry wanted to deliver their training online. The project fell apart pretty quickly, but when Cameron and I tried to quit, we were offered the chance to start from scratch, and so much more.
Here’s how our relationship is structured:
- The product is wholly owned by our client.
- We have two contracts in place: A standard professional services agreement, and a separate royalty agreement.
- The PSA states that we bill for our expenses and our hours (at a reduced rate) every month.
- Quarterly, we subtract that amount from the gross revenues generated by the product.
- Our royalty agreement states that we receive 20 percent of the remaining net revenue, the remaining 80 percent belongs to our client.
- Either party can end the PSA without too much hassle, however the royalty agreement continues in perpetuity.
Why it Works for Us
We benefit tremendously from the domain-knowledge of our client. Since they have so much experience with corporate learning environments, they play the role of customer as well as a business partner. Because of their reputation and credibility, they also open a lot of doors for our product.
Our arrangement also lets us focus on our strengths, designing and building products for the web. They in turn can focus on managing accounts, and providing other consulting services to our clients.
And while we have to compromise to some extent in the specific direction the product takes, and what features will be included in the next release, it’s a collaborative relationship filled with good ideas and lots of debates. And once the features are decided on, we’re very fortunate to have partnered with a company that gives us a tremendous amount of autonomy to design and build software that satisfies the requirements we build together.
Every relationship has its disadvantages. The first, big, obvious disadvantage is that we don’t own the product, and we don’t receive 80% of the net revenue. However, 20% of a million dollars is a lot more than 100% of fifty thousand dollars.
We also don’t have exclusive control over deciding the direction of the product. Don’t get me wrong, we definitely have a strong voice at the table. But guess what? The only people that decide what features are really useful are paying customers.
In our opinion, the opportunities and benefits this deal brings to Big Bang Technology far outweigh the disadvantages. Especially when you consider the alternatives. We feel like we’re living the dream, building software used by major companies in the United States, and more importantly, we’re using these opportunities to learn and apply customer development principles.
A lot of our friends have raised concerns about the “repeatability” of this model. How often can you find a successful offline business willing to invest in a product, offer such generous terms, and trust a company like ours who doesn’t have a proven track record? I don’t know, but if anyone here has any doubt that it is possible, I hope we’ve presented a compelling case.
Please feel free to yell at me or praise me on my twitter account.