The VC Paradox: Too Good to Fund

My sister is a psychologist and has a very prescient view about bank financing: "A bank will only lend you money if you prove to them you don't need it." This bank rule has worked for me, and I have successfully levered companies using traditional bank lines of credit.

On the other side of the coin are Venture Capital firms, which operate under a much different principal: Prove to them that you need the capital, and they will likely provide it.

Ironically, because I run a prosperous, self-funded hundred-million dollar operation, VCs keep telling me that a new startup our team just launched shouldn't require outside funding and that we should capitalize it ourselves with the profits of our already established business.

My sister's insights are helpful. Our sister company's profits are a hindrance. It's a business-funding Catch-22.

Getting Started

Allow me to rewind for a moment: A few years ago, I partnered with a wonderful group of guys and together we started Ultra. Today, it's the most successful mobile company to launch in the USA in quite a while and has topped the Inc. 5000 as the current #1 fastest growing private company in America and is on track to hit nearly $200 million in our fourth full year, and nearly 100% of the company is owned by the partners and employees.

Since its inception, Ultra's become a springboard for the team to innovate in the realm of free international calling. Last year, our co-founder Chris Furlong proposed the concept of an app that would allow people anywhere on Earth to be on our network, which would connect to every major mobile carrier in the world.

We'd build a virtual network, allow users to make free calls throughout the globe, and charge the biggest carriers in the world access to our users. The app is called Primo, and it required us to build a communications network that directly bridges the internet to the public phone system by marrying each user's assigned phone number to their phone or tablet.

Once the Primo app was written and networks and gateways were implemented, we then needed to meet two goals:
• We needed people around the world to download the Primo App, use it to make calls, and allow others to call them via the internet.
• We needed most of the world's existing carriers to agree to send their traffic to Primo users. For this, we needed money.

The VC Perspective

The VCs initially loved the idea but followed by asking, "Why come to us for seed funding? We can give you $2 million to build Primo, but we'll want 30% of your company. Since you're still in the early stages of testing, wouldn't it be better for now to just fund it yourself?"

When smart people offer advice, it's a good idea to take it -- and we did. Two million dollars later, the app was working, and we still owned 100% of Primo.

We called upon the VCs again, showed them the new app and asked, "Ready to fund?"

Their paraphrased reply was, "You're still learning whether there's actually a market for Primo and, at this point, it won't take much more money to put it in the app stores and see if there is demand. If it turns out a dud, we just lost or money. Conversely, if there is big demand, you'll have given up a huge percentage of your company at the worst possible moment."

Once again, they were right. We decided to put a bit more money in and launch the Primo app ourselves.

Launching To Gauge Interest

The launch was successful -- ironically, it ended up being too successful for us to handle. We decided to launch Primo in beta, targeting one specific corridor of international calling before building a network large enough to handle the world's traffic. We chose the market of the Indian community in the Middle East calling back home to India, and vice-versa.

We figured we'd spend a couple thousand dollars letting people in that market know about Primo and get about 10,000 users testing the app within a month or two. We built a system that could handle 1,000 simultaneous calls per minute, which would be more than adequate for 10,000 users.

Within six weeks, we were slammed: Over 250,000 users had downloaded Primo. Our gateways, our servers, and our bandwidth were all busting at the seams, and 25,000 new users were downloading Primo every day while we were trying to fix it. Our first action was to pull the app from the stores to give us some breathing space to scale up our platform to accommodate this type of growth.

Our second order of business was to call a few VCs. At this point we had validation from the market: We'd shown demand for our Primo App, and we'd shown that we could acquire users at pennies on the dollar -- a fraction of normal app download and engagement costs.

Finding a Sustainable Path to Growth

Additionally, we had over 200 carriers around the world signed up and interconnected, ready to send traffic to Primo users. At this rate, an additional $5 million would get us to 40 million users and an additional $50 million would see us overtake Skype in terms of users by the end of the year! What kind of investor could turn down an opportunity like this? So far, every VC we've asked.

Their current rationale is that Primo is trying to grow too quickly. Like other high-growth companies using the freemium model, we do have a small cost of goods sold because we make it free for users to call mobiles and landlines -- something none of our competitors are in a position to do -- but, as a consequence, our advantage is also our curse because growing quickly means we have to fund this growing COGS, too.

They suggest we change our business plan to prove our monetization strategy sooner. Get profitable with a fraction of the users and then use those profits to grow at a less logarithmic pace. It's downright perplexing.

Eight of the 10 most popular apps in the world are free messaging/communications apps, and they have an average valuation of over $25 billion. Yet VCs aren't interested in backing the next one because it is growing too quickly and requires money to grow? That is a VC paradox.

Once again, we are listening to the wisdom of the VCs and slowing our progression because we don't have the funding to handle the organic growth we could be garnering. We are paring down our costs, measuring demand by reeling back a significant amount of the free services, testing multiple up-sale offers, and looking at alternative ways to self-fund our growth outside of VCs until we hit that sweet spot they want.

Will we ever hit that perfect balance of fledgling rookie and flourishing success story that seems to be a prerequisite for VCs? Will we find a VC that is willing embrace our growth or will we bypass that altogether?

Stay tuned.