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How To Fund a ‘Fat Startup’

Posted on Tuesday, Apr 1st 2014

These days, we focus a lot more on lean startups than startups that require capital to get going. The entire industry has moved away from the ‘fat’ startup category. Investors expect that you will have your product launched, customer acquisition model fleshed out fully, and a team in place before Series A.

However, infrastructure software, hardware, networking, chips – they need capital. Even in cloud software, to build complex technology like personalization and analytics requires some investment.

While in the 1M/1M program, we steer people mostly along lean startup paths, I have pondered and investigated the question: How do people fund the ‘fat startups’ these days?

I am seeing a few trends:
- You need track record to get VCs to write big checks right away, so, often, it is the serial entrepreneurs who get these opportunities.
- Some VCs incubate such companies with their Entrepreneurs In Residences, who are typically serial entrepreneurs.

For first time entrepreneurs, the options are more limited.
- The most viable option is to bootstrap using services. This HBR article elaborates on the subject.
- Deep domain knowledge in a certain business may also give you access to capital.
- A coherent, high-powered team that is willing to work for equity and build a prototype, along with a clear vision of product, customer need, customer acquisition model may, sometimes, work as well.

A few examples from our Entrepreneur Journeys series:

Ash Ashutosh is a serial entrepreneur who worked as an EIR at Greylock, a top venture firm, and once he scoped out the market need, Greylock gave him the money to build the product. In effect, Actifio, Ash’s fat startup, was incubated inside Greylock, the venture firm.

Andres Rodriguea, founder of fast startup Nasuni, has deep domain knowledge in storage and he is a serial entrepreneur with track record. Raising money was based on those two core factors.

Alon Maor, CEO of fat startup Qwilt, demonstrates an interesting use of bridge financing with Series A (typically, the first institutional round of financing) already negotiated. The product was released 20 months AFTER Series A, which means, the Series A financing happened without much other than a clear vision of what the product was going to be and feedback from customers that they wanted the product.

Alon says, “In our case, since we are approaching the carrier space which is a large software-based capital intensive project, the incubation we did was through 15 worldwide carrier references. We had endorsements from those carriers who said they were behind the idea and recognized our approach as the future of the market.”

Alon did something very nifty. He went to Silicon Valley VCs and sold the concept, got an idea that they would be willing to fund his Series A based on the proven customer interest. He also put together a high-powered team of 10 people with deep technical expertise ready to join upon funding.

Then, and, here the story gets really interesting, he went to a set of angel investors who knew him from prior companies, and raised a seed round as a bridge into the Series A.

Complex? Yes. Smart? Yes. I would say, very smart.

In this case, funding happened because of a combination of factors: domain knowledge, customer interest, VC interest, and evidence of a strong team ready to come on board post financing.

Austrian entrepreneur Alexander Zache has deep domain knowledge in Art Auctions. He is a first-time Internet entrepreneur from a family steeped in the arts business. He managed to raise series A financing from VCs in Berlin on a slide-deck that explained the core concepts, including a phenomenally lucrative business model: Auctionata takes 20% commission from Buyers and 20% from Sellers, competing head-on with Christie’s and Sotheby’s.

Alex says: “Yes, and we have a very credible strategy for bringing that business online. When I look back at that presentation today, I can see that we have executed exactly what we said we would. We have also hit the revenues exactly as we said we would.”

Please note, there are certain VCs who are particularly good at these kinds of investments, especially Asheem Chandna and Vinod Khosla come to mind in the IT infrastructure space. Asheem Chandna’s investment in Delphix is a good example of funding a fat startup based on a concept. Delphix was founded in 2008 by entrepreneur Jedidiah Yueh who had earlier founded and sold data de-duplication company Avamar to EMC for $165 million. Vinod Khosla is one of the very few VCs who have not abandoned his interest in Cleantech, a capital-intensive industry where the lean-startup model has limited applicability.

While the industry is obsessed with lean startups these days, I believe there is tremendous value in understanding how to continue to build fat startups as well, alongside the lean ones.

 

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