There are many businesses that are capable of becoming very large ($50-100+ million revenue) businesses. These businesses need cash to grow. In the right circumstances and in the right amounts, venture capital is the best way to scale the business.
But raising venture capital is like adding rocket fuel to a business and for many early-stage companies it is not warranted and dilutes the founders/start-up team’s return significantly.
There is a common perception, especially in Silicon Valley, that venture capital is the pinnacle of building a company. The conventional “wisdom” is that young entrepreneurs should come up with an idea, write a business plan, go out and raise venture capital, and voila, they will strike it rich!
Many young entrepreneurs think that if you can raise money through venture capital, you can make millions with no downside. Get a high valuation, pop some champagne, and then go home a success.
It’s a mistake to go out and raise venture capital until you know with certainty that you have a sustainable business and that you can build value for your investors. If they need a 3x return, make sure the company can deliver three cents for every penny invested; if it is a 10x return, make sure that the company can deliver at least 10 cents for every penny invested.
You have to think about returning money, not taking money. If your investors expect a 10-to-1 return, you must return 10-to-1, period, without exception. If you don’t think you can do it, get out of the startup game or don’t raise venture money. Plenty of companies have become successful without venture capital; it’s a mistake to think that you need it.
There are a few rules-of-thumb that are recommended for most early-stage technology companies:
Raise a small round of capital – usually from angels or from the three F’s (friends, family & fools): $100-200k
Use the small round to get a product built, sign up pilot customers and get the initial team in place.
Raise a round of angel money/seed capital: $250k-$750k
Keep the burn rate really low for the first year. The goal is to prove to the investors and the start-up team that the business is scalable.
Assess the situation in 1 year. Many businesses will find that within 15 months into operations they will know whether they can carve out a meaningful position in the market to build a small company.
VC Route – If the company is at this point and believe it can be a really big business ($50-100+ million in sales) then it is time to start thinking seriously about VC funding.
Alternative Route – Companies in the more likely situation where they can see how to grow the business from $1 million this year to $3 million within 3 years and maybe $8 million within 5 years, then VC may not be the best option. Generally, VCs aren’t looking for companies that are doing $15 million in sales in 8 years from their investment. In this scenario, a combination of bank debt, venture debt, and a small equity raise ($1-2 million) from high net-worth individuals may be the more suitable option.
Desperate for Cash
If your company is in desperate need of a capital infusion, you are far too late to be raising money from a VC. Desperate times call for ingenuity, not capital.
If you have dug a cost hole, don’t fill it with cash. Instead, find a way out first. Take a deep breath, and then figure out the next step and who to partner with to build your company.
The best (and only) time you should raise venture capital is when you aren’t desperate. Better yet, raise it when you don’t need it at all.
Not Looking for Money but Looking for an Investor
Ultimately, building a company is about solving a problem, meeting a need, and creating lasting value.
Businesses are all about people. The people you bring in to help your business thrive should be people who are on board with your mission, and with whom you can establish lasting relationships.
Bringing an investor on board is the same thing as finding a CFO, or a spouse, for that matter. Ultimately, you are looking for a long-term partner.
Find investors whose principles are aligned with yours, and with whom you can imagine working with again and again. If you have the right partner, and you know your company can return substantial value, then by all means, accept their money.
Let me know what you think about raising money from a VC or not by reaching out to me directly at email@example.com.
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