The tech-capital of the US is gushing with venture capital money. The problem? Many start-ups develop too strong a penchant for “free” and never actually become businesses. Jason Fried explains why not having money is the best way to create profit.

Question: Why has Silicon Valley drifted so far from the fundamental tenets of business?

Jason Fried: I don’t know how it happens, but I think fundamentally, it’s all about venture capital. The more money that’s available and the more the culture is about going out and raising money, and the more it just happens and it just feeds on itself. If the venture capitalists weren’t there, there would be a lot of empty companies that wouldn’t be there. And that probably would be better. Not in every case, but in most cases. I think it’s better when you are forced as an entrepreneur to bootstrap. And here’s the fundamental reason why. You have two companies, one that’s bootstrapped, one that is self-funded, and one that’s got venture capital money in the bank. The primary difference is this, on day one, a bootstrap company has to make money. On day one, a funded company has to spend money. They have money in the bank to spend. That’s their first task is to spend. To hire, to get a great beautiful office, to do all that stuff. That’s what they have to do, they have to spend money.

Unlike a bootstrap company that doesn’t have money to spend, they have to make money first. And I think that’s the right instinct for an entrepreneur to start out with is the idea that, “I’ve got to make money.” That’s the right thing. And I think what happens is, especially in Silicon Valley where there’s a lot of spare money around, people are handing it out essentially, that you don’t have the instinct. The instinct isn’t built to make money; the instinct is built to spend money. And then that kind of just perpetuates itself, and people don’t have to make money because other people are paying for things. Until the money runs out and then you’re kind of screwed and then it’s too late because you don’t have the skills to make money. So, that I think is the problem with Silicon Valley.

Question: What distinguishes well-funded start-ups from “bootstrapped companies?

Jason Fried: Well, I think the thing is, is that not having money, or having to make your own forces you to make really smart decisions and good decisions and makes you think about stuff. For example, if you win the lottery, you’re probably not going to make good decisions about how to spend your money. You’ve got a lot of it, so yeah, I’ll buy a house, I’ll buy a boat, I’ll buy this stuff. You’re not actually making decisions, you’re just spending money. But when you have very limited resources, you’re forced into making decisions that make sense. Does it make sense for us to spend this money on marketing? We have it, should we just blow it. Or, are we not going to get a return on it. And you start to think about these things and you start to find yourself wondering, does it make sense to hire 20 people, or should we hire two. We can afford to hire two, so let’s hire two really good people, that’s all we can do. And when you’re forced into those constraints, you just make better decisions.

I always look at, this is probably a weird analogy, but I tend to look at prisoners in jail, how they make these weapons where they’ll take like a pen and a piece of tape and a comb and they make, they can like break out of prison with that. But if someone had all the money in the world to break out of prison and they would buy a jackhammer and they would buy chisels and stuff, they’d make too much noise, they’d attract too much attention and it wouldn’t work. They’d have all the resources, but they’d spend them and wouldn’t spend them wisely. But the person who has no resources has to make something that’s very, very simple and that is just as effective. And that’s sort of the mentality I think that you see in bootstrap companies. We don’t have the resources, we’ve got to make something that makes sense and we only have one shot at it. So, we’re going to do a good job. And just do exactly what we need and not all the things that we could do.

Question: What mistakes might you have made had you been better funded?

Jason Fried: Yeah. I think we would have probably hired a lot of people if we had a lot of money. That’s just something you tended to do in the late ‘90’s. I heard of so many companies say, we’re going to staff up. And it’s the stupidest, fucking thing to say. Staff up? We’re going to staff – well how about we’re going to hire somebody that we need? What’s this idea of staffing up?

There was this thing going on in the ‘90’s. I remember people saying we’re going to staff up to 100. Where people are saying, “Our company is this big,” when they’re talking about “this big” they’re talking about employees. And it is very easy to get carried away with that. And thinking that you’re inferior unless you have a lot of employees. So, I think that’s something we probably would have done. We probably wouldn’t have put money into marketing that would have been a waste of money, we probably wouldn’t have put a ton of money into PR; it would have been a waste of money. And it wouldn’t have forced us to be creative about how to get the word out, which is something that we’ve learned how to do over the past ten years without having to spend money.

So, maybe done some things, but I think the real thing is we would have missed learning the important lessons. That’s what I think we would have suffered most over.

Question: Can any company grow in the way 37signals has?

Jason Fried: Yeah, well my feeling is like, stuff that I like to talk about is really about my business, my industry. So, my ideas don’t necessarily make sense for a restaurant, or for bowling, for example. But their ideas don’t make sense for me either. So, they shouldn’t be giving me advice and I shouldn’t be giving them advice.

What I think though, in the software business, which is the business we’re in, or a service business, which a business a lot of people are in outside of the technology world where you don’t have to have a factory, you don’t have to have raw materials, you don’t have to have machinery, you don’t have all these upfront costs which would typically require you to raise capital. You don’t have those costs, they you shouldn’t get the money that you might need to spend to buy those things. In the software business, you need a computer and an internet connection. It’s like, a couple of grand to get started.

But if I’m building a factory and I’m making widgets, I might need to raise hundreds of thousands, or a few million bucks to make that big capital expenditure. So, I think if you don’t have the raw capital expenditure requirements, then you should not be raising money up front.