Well-Funded Competition Forced VC-Free FreshBooks To Take Investors After A Decade Of No's

For twelve years, Mike McDerment has run FreshBooks out of Toronto to be self-sufficient. But when your market gets hot, you don't want the smallest war chest. So even as FreshBooks announced its first major funding round today, its decision to take venture capital after years of growing on margins shows just how fast the market environment can change--and why the benefits of going it alone can become less attractive fast.

FreshBooks raised $30 million, it announced Wednesday, in its first institutional round from Oak Investment Partners, as well as Atlas Venture and Georgian Partners. The money's supposed to help the company grow at a faster clip, expanding what's currently a team of 150 to 400 in the next two years. They'll help with engineering and sales and marketing. All that's pretty standard as a use for funding.

But since raising $100,000 from friends and family when the company first started, FreshBooks and its CEO have eschewed venture backing. In the fall of 2012, McDerment told Bloomberg that while he had no specific rule against taking funding, venture investors didn't have much appeal to him. VCs build a portfolio with a few bets, they look for patterns and ways to improve a company's operations, and they expect an eventual return. And he was adamant that any investor in FreshBooks would need to be one that wouldn't take stock with liquidation preferences that would allow them to cash out even if the company tanked.

Fast forward to 2014, and McDerment's taken on the growth capital he was loath to consider before. What's changed? Venture funding begets more venture funding.

By selling software to small businesses to help entrepreneurs and shopkeepers who are not professional accountants run their businesses and manage their expenses, FreshBooks has long gone against QuickBooks and its parent Intuit , a company with a market cap of more than $23 billion. FreshBooks' user base of 10 million is centered around North America, and while it may now look more internationally, that's allowed fast-growing competition to set its sights on the U.S.

The lead challenger, as McDerment knows, is a New Zealand company, Xero. That company's got more than 200,000 paying customers already, and most importantly, it's setting its sights squarely on the U.S. market. Back in October, Xero raised $150 million of funding of its own, the majority of it from U.S. investors led by Matrix Capital Management and Valar Ventures, Peter Thiel's venture firm focusing on companies from outside the U.S. Valar's mission is specifically to help such companies expand aggressively stateside.

McDerment says he's happy to keep his company in Toronto, where he says there's plenty of talent and a strong employee pool. "I find Silicon Valley a great place to visit," he says. But his lack of interest in big-firm backing may have put FreshBooks in a precarious position moving forward.

It's hard to say whether FreshBooks got better terms with Xero as a validation of the market or worse as Xero threatens its core market. But the company probably could've gotten a lot more than $30 million many months ago, when it wouldn't find itself outgunned and playing catch-up.

The company didn't take the highest valuation available and was careful about finding firms that fit, McDerment says, and on his earlier claim he wouldn't allow for liquidation preferences, he just says "I think we wound up in a great place."

FreshBooks has been doing something right over the past dozen years to get where it is, so it seems unlikely that taking funding was needed to save a struggling company.

"We wanted to make sure that our bank account reflected our ambition, and our market is really ready to grow now," its founder says. "More customers are choosing a solution, and there's more attention on the market, but it's still hugely fragmented."

But more attention means more competition, and FreshBooks may ultimately wish it had shown more aggressive ambition, and the coffers to match, years ago. The company's about-face to take venture funding shows quickly a market can turn--sometimes faster than the founders who've made things work for months with an approach they're then reluctant to shake.