There Is No Free Lunch

I am reminded time and time again that things that sound too good to be true almost always are. There really is no free lunch, in business or in life.

Here are a few examples of things that seem so tantalizing to entrepreneurs and the companies they create but turn out to be just as costly (or more) than the alternative:

  1. Taking on debt instead of equity in the hope that it will be paid off in the future with equity sold at much higher prices. Or convertible debt that converts in the future at a much higher price, which is basically the same thing. I have seen this go badly so many times that I now almost throw tantrums when our portfolio companies choose to do this.
  2. Raising another round to buy more time to figure out the business model vs figuring out the business model now. “Buying time” is one of the greatest free lunch fallacies of all time. I strongly believe that now is almost always a better time than later to do something.
  3. Hiring a service provider (lawyer, accountant, PR firm, etc) who will do your work for free in return for your company’s business later. This sounds great but unfortunately locks you in to using this firm later on when others may be a better choice for your company.
  4. A big enterprise company will pay you to modify your software to work “better” for them. Sounds great now, when you need the revenues/cash so badly, but little did you realize that you just outsourced your roadmap to a big company.

I could go on and on, but hopefully I’ve made my point. I encourage everyone to make the hard and painful choices when they have to be made and avoid the free lunch fallacy. It mostly leads to indigestion.


Comments (Archived):

  1. sigmaalgebra

    > Raising another round to buy more time to figure out the business model vs figuring out the business model now.Right, dumb de dumb dumb, very dumb: That’s just thinking and needs mostly just think time. Doesn’t need a COO, CTO, CMO, CFO, HR, Assistant to the CEO, Assistants to all the C-Level, rent suitable for C-Level top level super highly qualified can’t write code dead wood or the associated high burn rate.Get as much done as possible before raising the burn rate.> Hiring a service provider (lawyer, accountant, PR firm, etc) who will do your work for free in return for your company’s business later. This sounds great but unfortunately locks you in to using this firm later on when others may be a better choice for your company.I’ve been offered such services. So far have not taken any. But why locked in?But free lunch is not entirely a fallacy; things close to a free lunch exist. Similarly for a license to print money — sometimes they nearly exist. Generally high margins, high ROI, growing a fortune quickly are all possible at times.A free lunch? Ah, we need some examples!(1) Drudge Report.At in part VISITS TO DRUDGE 06/05/2017023,942,633 PAST 24 HOURS837,650,165 PAST 31 DAYS11,064,303,295 PAST YEARAt anything like common ad rates, Drudge has something much better than a lifestyle business.For a lot of people who have worked hard for each dollar and saved hard for each dime, what Drudge is doing looks like a free lunch.(2) Plenty of FishThe romantic dating site Plenty of Fish started by Markus Frind, long just Markus, two old Dell servers, ads just from Google, and $10 million a year in revenue, as at…is in partMatch Group Buys PlentyOfFish For $575M To Bag More Singles (3) Bell Labs and the TransistorBell Labs was nice enough to give rights to the transistor to the world.Alas if they had a royalty of a penny per transistor, then by now they would have owned the world and everything in it.(4) Xerox Electrostatic PhotocopyingFor some years, Xerox with their electrostatic photocopying had nearly a license to print money.Likely there are some other examples in pharmaceuticals.Some of the recent work in genetics will likely create some more examples.Anyone with a good background in research can be within a few hours of an idea that can easily become nearly a license to print money.

  2. Chris Montes

    Hey Fred,for point #1 are you referring to convertible debt pre-seed/seed or a bridge at the series A/B/C rounds?

    1. fredwilson

      All of it

  3. Donna Brewington White

    Seems like #1 is a whole post on its own — which you may have already done.Wasn’t paying attention before, but this option (debt vs. equity) seems to be coming up more in conversations with clients and prospective clients — which can make a difference to the people thinking of coming on board.#3 — Some of my savvy competitors have taken equity in lieu of payment (for executive search work). Seems as though this could have the same effect?Of course, this is one of those posts where I expect some great input in the comments. Can’t wait.

    1. awaldstein

      It depends Dona. It happens all the time with recruiters and honestly with the right structure can be a good for both sides.

      1. Donna Brewington White

        I can see this. Especially good from the recruiter’s end because it is easier to walk away after the initial transaction(s). But I’ve seen companies that feel stuck with continuing to use a recruiter who is now an “investor” even though would no longer be their first choice. I don’t want to generalize 2 – 3 examples, though.

        1. awaldstein

          Agree that being careful and open to the uniqueness of each circumstance is important.I’ve learned to walk away when it no longer is a beneficial situation, remove all future commitments and ensure of course that comp for past is clear if it comes to pass.

  4. kenberger

    5. Buying a modest bit of BTC and ETH, etc, sitting tight, and cashing out later?

    1. kenberger

      I’m being ironic, since a friend of mine just did exactly this and now has a lifetime of free lunches, dinners, and homes to eat them in, ahead of him.

    2. jason wright

      Yeah, it’s that easy.

  5. Anirudh Nellutla

    Hi Fred,All of these are great points and I have myself seen these play out too.However, it would be great if you could elaborate on point #4… mostly because, as an entrepreneur myself, I find it to be actually a great way to get revenue in… from your experience, what kind of issues have you seen cropping up when #4 is resorted to?

    1. Vitomir Jevremovic

      If it is not in a line of your roadmap, it distracts you from creating a sellable product, thus making you a service company instead of a product company.

      1. Anirudh Nellutla

        true – even if it is in the roadmap, accounting for all the variations makes our devops work very hairy… does it have any issues wrt problems with IP etc later on? Have you seen such cases?thanks 🙂

        1. Vitomir Jevremovic

          if you have enough money to keep you focused on a roadmap, you should only take client requests as a feedback not as job. Compile all of the feedback in something that aligns or changes your roadmap, and then work on it. We regulate IP through service contracts always keeping the IP.

  6. Vitomir Jevremovic

    Isn’t VC investment a form of a free lunch too? Reframing the points: 1. You also hope. 2. You already raised a round without business model. 3. You hired a VC

    1. fredwilson

      Hell no. You pay for the cash in equity and you don’t have to give it back. The cost is clear and paid upfront

      1. Vitomir Jevremovic

        Debt is a legitimate vehicle in some cases, although it’s a rope around ones neck, but from free-lunch perspective, selling equity is more free-money then debt is, especially if business fails. Yes, debt is bad, but equity traded for a free-lunch is a motor for entrepreneurs and what made VC industry great.

        1. Pointsandfigures

          Debt is a tax on the future cash flows of the company. It’s a double edged sword not a free lunch.

          1. Vitomir Jevremovic

            True, though I think Fred referred to paying out debt through equity, which is a way of betting on valuation and investments instead on revenue and profits. Too much gambling anyway.

  7. jason wright

    When does a convertible debt note execute for equity?

    1. fredwilson

      Good question. I’m never clear about that unless we negotiate it

      1. jason wright

        perhaps Vitalik will know… when they’re all smart contracts running on decentralised corporations.but i’m a Beareum.

  8. awaldstein

    #3 I personally work for equity as an advisor in some circumstances. And have given it out at times as well. It can work well, depends on the context.#4 Impossible to sell to the enterprise and not have this be part of the selling process. Tempting at times to be shortsighted. Biz dev and enterprise sales are truly strategic processes that require being smart about this.

    1. leigh

      equity is different than a promise 🙂

      1. LE

        Look if someone asks you, you have the time (and enjoy doing so to boot) to do free work then you can think of it as the cost of acquiring a potential future customer. The same as if you ran an ad, attended an event/convention or convention or did other types of marketing. So honestly it really depends on the amount of money involved, how established you are, how much free time you have and most importantly the time required. You could call it a loss leader. At the very least (and assuming you do a good job) you now have a reference that you can point to to get future work. If you are established and busy then you don’t need that reference. Fine.Let’s take an extreme and what I will call ‘the governor example’. If Warren Buffett gets in contact with you (or his ‘peoples’) and asks you to do him a solid (for whatever reason let’s say it’s a non-profit) I am guessing that most people will take the time and energy to do that. And not because it’s a non-profit either. That’s an extreme example that I am using to prove a point. Depending on what stage you are at in the consulting process there are many people who might be even more helpful to your future career. Once again advice to people starting out not to you as an established vendor.On a more serious note:Flight of the Conchords: ‘A kiss is not a contract but it’s very nice..’…

    2. ShanaC

      4 should be *with limits*. customization is good, totally new products so you become effectively a consulting company is bad

      1. awaldstein

        If you have negotiated a lot of these deals from a position of weakness, which is where all startups are, then the line between good and bad is clearly always grey.Easy to make rules and general dictums. Hard to see the light in the trenches.

  9. leigh

    Speaking as a service provider, I’ve stopped doing any marketing at a discounted rate for startups with promises about what they are going to do for and with us in the future. If they don’t want to pay for building their brand on day one, they aren’t going to magically decide they value outside agencies for marketing later on. Gonna cc: @SixgillBlog:disqus to see if his experience is any different (oh and ps. this has only increased the desire for our work … funny when you charge 4X as much you are valued 10X as much)…

    1. awaldstein

      I don’t do discounted work any longer. I don’t sell futures, though in essence that that is what startups are selling of course.I do create structures that are part equity of course but nothing is a promise.I live and die by my rep and there have been a few instances where I’ve walked away from a contract where the direction of the company has changed where my equity was needed for different expertise.In the end we all win from that.

    2. BillMcNeely

      I see this for subject matter experts over all with startups. market for your expertise will be W you discount yourself to Y to help and then the startup will hit you at a still lower X with an undocumented promise for equity.

    3. Anne Libby

      I don’t discount, either.

    4. PhilipSugar

      I would say the same thing for big companies that say having their name will give you cache.And you are spot on the 4X and 10X.If people view you as the “cheap, little provider that we could push around” you always will be viewed as that. When you try to raise prices, they will push back or fire you for the “high end provider”

      1. LE

        I would say the same thing for big companies that say having their name will give you cache.In some cases there is a nice benefit to being able to have as a reference or as a customer a company that the people you are pitching later have heard of and either fear or admire.Being associated with a known company name does have an impact on many things (hiring, selling, employees, publicity) and so on.Similar theory – one only has to look at Fred Wilson as an example. He is associated with several companies that are well known and that people have heard of (in tech) and as a result they tend to view him positively because they have secondary meaning to those companies. They have heard of them. While there are tons of companies that are much larger, profitable and more successful that nobody (in tech) would bat an eye at. The press cares about this as well. If you read a news article they will often bandy about the fact that someone did work for Four Seasons or some prestigious corp. as if that makes them more legit.If you have to start explaining (as a consultant) who your clients are, that is if they don’t off the top mean something to who you are pitching, then you are going to be disadvantaged.

        1. PhilipSugar

          I would say you build reputation by the eyedropper and lose it by the bucket.I hate the “too good to be true” mantra because many people use that against disrupters.But if you have a shit deal with a big customer, they will treat you like shit and other big customers will do the same.

        2. leigh

          When we needed some case studies for design work, we used that strategy strategically. But actually the thing that worked best was non-profits who greatly benefited from the work, we did good in the world, and had a full case study of our process and what it can do.

      2. awaldstein

        This is why I love enterprise sales for startups.You have to sell the opportunity regardless of your size.Did a project in IoT last year building a platform into the enterprise that honestly was the most fun I’ve had in awhile.Of all the thinks I could do and not completely run the show, doing this type of work is probably the only thing on the list.

    5. Donna Brewington White

      Thank you, Leigh!

  10. Tom Labus

    #2. With a side of “I know there’s a company here. Just need some time.” And not many don’t order this as many times as they can.

  11. Michael

    #4 would be interested to hear of some examples of this going wrong, I have recently seen 3 start ups successfully build out a new product for enterprise by ‘tweaking’ their product and making it better for client. Enterprise has paid for this, and got a soultion to their problem, tech co have then going on to repackaged built a small team and gone to sell to the market..

  12. Matt Zagaja

    “The only free lunch is the one you avoid eating.” – Warren Buffett(not at all a real quote, but should be?)

    1. Girish Mehta

      Nice !

    2. Matt Zagaja

      The real key to lunching: “Freemium.” Give them a free lunch, but offer a selection of delicious drinks they can pay for.

      1. ShanaC

        actually, a good term to think about”amuse bouche” – give them that

  13. Jon Eckhardt

    Can you eloaborate more on #1? Thanks.

  14. Jon Carmen

    What would you recommend to seed stage companies that are raising their first round? Many seed investors (first outside money) like to do convertible debt. For example, up here in Buffalo, NY, there are 4-5 groups that do seed stage angel investing. All but one prefer convertible debt.Jon

    1. Pointsandfigures

      This is a hard problem that we encounter in Chicago too. The other thing about convertible debt is lawyers charge lower costs. SAFE’s might work better for entrepreneurs than convert debt. I am empathetic to the problem of finding a lead. What you can do is set up a special purpose vehicle LLC and dump all the angel investors into that so it occupies one line on the cap table. If you set a fair price, experienced investors should have no problem with doing that.Personally, I prefer the rigor of a priced round. It will cost you more upfront, but it will pay dividends in the future. Also I can stress this point enough’ Organize as a Delaware C Corp. Get an attorney that really understands venture-precious few actually do although there are a lot of attorneys that want to “learn” on your deal. There is no other option if you want to raise VC money.

      1. Jon Carmen

        Thanks. I understand why seed groups prefer it and it can make the process quicker, but to Fred’s point it doesn’t seem like the best choice

  15. William Mougayar

    #4 is a classic mistake for those with an enterprise focus, especially if said customer is also a strategic investor. They will keep spinning you with new demands to fit what they want, because each enterprise is different.We went down that path with Eqentia. At one point, we were custom delivering 3 projects because we needed the cash. That de-routes you from building a product many other customers want.

    1. Vitomir Jevremovic

      There is a one special case, when your product emerges from your first customer

      1. William Mougayar

        yup, as long as you don’t get derailed after.

      2. PhilipSugar

        Sorry but if that is the case I have never seen it really be a product.

        1. cavepainting

          That’s not always true. If the founder has deep product sensibility, understands what should be in the product vs. custom, it is very much possible to build your product out of the first few or even the first customer deployment.What is not possible though is to have no product sensibility, deliver full-blown services and yet build a product company over time.The reverse can also be true. i.e. you have no customers, have been building a product in an ivory tower based on customer development, and when it comes time to deploy for someone, you realize you are way off. Now you are even in a worse situation than if you had started with a specific customer in mind.So, it really depends on who are the founders, their backgrounds and approaches to building the product and the company, their depth of understanding of the problem space and the solution, and how they exactly do it.

          1. PhilipSugar

            Maybe I’m taking semantics too far. We agree.Sure if you sell your first product to a customer, the first customer is going to have a lot of control, but as you correctly state if the founders know what they are doing it works.But I have seen tons of “products” which were really just custom built for a customer fail. Accenture has so many examples. The problem is that if they are paying you to code they will say just do it. If you sold it as a product you don’t get paid to add features. (well as Mark Suster says not often)Let me give a real life example. We had a client that had to have a feature and they wanted it to be “body of water” (it was a pool company)We said we would put in a feature called property which is what you own.They said no it has to be body of water and in fact it would have been much easier to code that way.We refused. Now they were very upset because they just wanted their hierarchy coded and didn’t want to enter it in to fields (damn some people are lazy). They told me that we were not serving them.Now that feature is used by auto parts stores and furniture companies. (what car or house do you own?)But I guarantee if they were paying us on an hourly basis we would have bent.

          2. cavepainting

            I agree. Makes sense.

    2. awaldstein

      It goes both way.I can think of three of my deals with Dell, with HP, with Accenture that this worked out well and in two instances they were investors.I also have ones on the other side of the fence of course but I think it is incorrect to say that they should never be broached.

      1. LE

        A big thumbs up on this one. Not only do details matter – each situation in business is different – but the more experience you have [1] the better able you are to navigate dangerous waters and come out ahead.[1] And I am guessing that you had decades by the time you struck those deals.

    3. James Ferguson @kWIQly

      I think there is an exception – when the client is a whale that is representative of a very large class of business (ie if the changes carry you toward your true north faster than you could alone)

      1. William Mougayar

        It depends if you want to productize your offering or if you are providing a custom service.

        1. Marcosardi

          It’s not that clean. When a large company starts using an emerging product, they usually discover that a few things are missing for them. Then the entrepreneur has to decide whether implementing said features will benefit the product or not. Even if it’s a one off, it might be worth it to scale the product and learn. I agree that doing this only for the revenu is big mistake.

    4. mrubright

      Agreed, William. Even further – most enterprise customers go into these agreements with the forward-looking intention of bending roadmaps to their business need. Once you’ve committed to the enterprise customer CR once, you’ve locked yourself into the mental trap of “losing revenue” rather than forgoing the opportunity. Dangerous cycle/mentality.

      1. William Mougayar


      2. PhilipSugar

        I just could not agree more. Just not more.I don’t know you but I know you have learned this lesson the hard way.I don’t mean that in a bad way, I have learned it that way too.

      3. cavepainting

        It depends on what is needed to deliver the promised business outcome and the maturity of the space.It is very easy to say “I would not do this for the customer”, but you better be in a space that is evolving where you have some leverage (or) you have built the product with open APIs and the customer can use 3rd party SIs to get to the outcome they need.If not, burying one’s head in the sand and sticking to a predefined roadmap irrespective of whether customers get value from the product or not is a smart thing to do.To be successful, you need product sensibility, market sensibility, and customer sensibility. The proportions vary depending on the stage of the company and the market. But one without the other two is not a good cocktail!

    5. Twain Twain

      So many things de-route founders from building the product that customers NEED.A lot of folks in the enterprises with budget signoffs are MBAs who may not have worked in innovative startups before. So their frames of reference are pure above-line revenues rather than below-line costs of tech infrastructure investment.Pretty much all the revenue prediction models have poor data sets and are linear with no visibility on the compound/quadratic utility of the tech innovation.

  16. aminTorres

    After reading this I get the sense that everything that is not bootstrapped, is free lunch then.

  17. Pointsandfigures

    TANSTAFL. Name of a cafeteria at Univ of Chicago. Milton Friedman, “There ain’t no such thing as a free lunch.” Anyone who is successful has near death experiences. Anyone who is successful has to make choices because of costs/opportunity costs. Nothing worth pursuing in life is free.

    1. Donna Brewington White

      Anyone who is successful has near death experiences.Oh my that hits a nerve. #Truth

    2. ShanaC

      It wasn’t a cafe, it was a snack bar in the Pierce Dorm. Pierce closed with the advent of South Campus because of its age and tendency towards exploding toilets. https://www.chicagomaroon.c…OTOH, you can sort of get a free lunch at the Regenstien library at Uchicago – historically, Ex Libris allowed people to sell their souls for coffee https://magazine.uchicago.e… Since proving you have a soul that was sold is problematic, it’s technically free. Just beware, for all you know you got the radiation poisoned food (kidding)

  18. Dana Hoffer

    I just completed one $2.4 million priced common stock Seed Round and am about to do it again for a new digital platform project. Priced common works very well. That is until you meet people that think convertible preferred is better. There are many more people out there than you think that would like a priced common share. Get your offering document together and be ready. Everyone can understand X cents per share & Y shares outstanding. Hardly anyone can navigate convertible preferred in one conversation. If your company is interesting and looks like a solid opportunity, you will simplify the process for yourself and your investors alike. Everyone benefits.Good post Fred. I wholeheartedly agree.

    1. Chris Montes

      Do you hunt for those types of investors willing to take common over preferred or is this something you persuade/negotiate?

      1. Dana Hoffer

        Chris,I pitch the company first and make sure I have done my part to explain the opportunity.Investors will ask “what is the structure?”I then say “the company is selling an X cent common share.”Largely these are individuals, not groups and not firms. Fred’s post sheds light and offers hope that some firms will buy priced equity. I have been successful offering priced equity.If there is something to negotiate the investor will let you know. Usually some cents off per share. In a recent situation an investor negotiated down 16% and then proceeded to bring in other individuals filling over half the round.There is a good lesson here… if you have difficulty explaining convertible debt to a person you are speaking to, that person has no chance to explain it to their acquaintances. In the above once the 16% concession was made no one asked about or questioned the structure or the pricing of the round. People understanding things is powerful in at least a few ways.If I follow this correctly, Fred is right on point.

  19. James Ferguson @kWIQly

    Agree hugely on hard and painful choices.However 1. Is what we did – And it was a hard and painful choiceWe just cleared all external debt out of growing revenues, (not equity), and now just need to pay founders back (those that committed disproportionate time or money) and who got us to this stage.We are working towards Growth stage, covering costs and need no funding. I am not sure this could have happened if we had not had complete control of our own destiny and utter freedom to take risks.So – although I do respect your opinion and I am sure it is right in some contexts – I suggest it must be true within your bubble and not necessarily applicable outside it.Next stage might be a different story !!!

  20. Darius V

    Isn’t all funding buying more time? Are you saying make your decisions with the information you have now rather than spend more to get more data points and decide later?

  21. vadimoss

    Easy choices – hard life. Hard choices – easy life… I wish I can credit myself with this quote but it’s from the Tim Ferriss Show:).

  22. Frederic

    Another one is building a go2market. I see so many b2b startups that plan to have partners do the selling and they always have invested way too much time to build a story why it going to happen in their case

    1. Sebastian Wain

      Yes, selling cannot be outsourced initially. It is wishful thinking that others will put the same energy and enthusiasm in selling your products.

  23. Collin

    One of my rules in business and in my personal life is that the more I dread having to deal with something the more important it is to deal with that ASAP. I also find that after dealing with it, the sense of relief is immense, and the problem wasn’t nearly as bad as I built it up in my head.

  24. Son

    Idea No 1 may not true totally. Using debt with the proper amount will improve valuation of business, when it can exploit the tax shield, lower cost of capital (because cost of debt often lower than cost of equity)….Of course, no free lunch because when your firm use debt, you will pay the creditors interest (that is expense of debt).

  25. george

    Witnessed a great startup go under due to convertible debt. Kicking the valuation can down the road fundamentally dilutes a founders interest and often complicates raising capital down the road. As you perfectly state, there is no free lunch – a note in exchange for a check seems like easy money but it’s often very misleading.

  26. creative group

    FRED:always wondered why free lunches are offered at the Tech companies.We knew it wasn’t really free…. :-)Captain Obvious…..

  27. Mark Evans

    If a startup can’t pay for services, that’s a troubling sign. It means they don’t value the services being offered or the person offering them. To me, that’s not the way to start a relationship.

  28. PhilipSugar

    To me it’s fairly simple:You should not take debt to build the equity in your business.You can/should take debt to offset hard assets that you need to build your business.Same for leases. Hard assets ok.It’s better to not take them, but if you need to then you do.For instance I’ve never bought real estate for my companies, I’d prefer the flexibility of the lease. Same for data centers.I have never capitalized software, that is crap, you are never firing developers.If I didn’t have the money and had the business lined up I’d lease servers or buy AWS which is essentially the same thing.

  29. PhilipSugar

    I would agree with Fred on this point: “You pay for the cash in equity and you don’t have to give it back. The cost is clear and paid upfront”Now I would quibble with you don’t have to give it back. Oh, you will, you will in spades before you get a penny.But I will use an analogy. (sorry to the women but this is just an analogy, but I don’t know the male analogy because I think women are much better))Debt is a cruel mistress, when you don’t have the money you are done. Equity is more like a spouse.I think taking on debt to figure a business model is silliness.Now if you have the business model and you are just investing ahead of the curve when you know you pay it back? Great.Now I would caution the road is littered with people that either convinced themselves or had other people convince them they need to invest ahead of the curve. (Sears from last century and Walmart from this one)