By Thomas Hawk.
We all follow the tech news closely. At the time of writing this post, Techcrunch’s front page has 6 stories about startups raising VC funding, 1 story about a later stage company starting to invest in startups, and 1 story about a VC firm having raised a new fund. The headlines about money are mixed with a couple of articles around recent developments for well-known companies, a smartphone review and (ironically) a story around a recent partner promotion at a VC firm. It’s clear that the combination of startups + $ generates interest within our community. 🤑 And a lot of the time, as a small unknown startup, getting VC funding is one of the few tactics around to gain some journalistic interest for your business.
Since a lot of the startup media bandwidth is dedicated to financing, amongst entrepreneurs there also seems to be an over-indexed belief that the path to success = venture funding. This. Is. Not. The. Case. Most companies should never ever consider raising capital. Here are my 3 top reasons why you should NOT raise VC funding.
1. Entrepreneurial success takes many forms
Success can be articulated in many ways. Most often it has to do with a sense of accomplishment, living according to your values, and freedom to pursue a life where you control your destiny. Very rarely is it defined by financial outcome.
Such is very much the case with entrepreneurship. Surely, if you founded Uber you would feel an amazing pride in having created a company with a global footprint which impacts people all over the world, and the financial upside is insane. However, a tiny satoshi of all companies ever make it into becoming 100 MUSD value range, not even considering the multi BUSD stratosphere.
But as an entrepreneur, you may just as well feel endless success and satisfaction by creating the professional freedom gained from having a 3-person team profitably delivering a product or service to a small part of the world. If that lean team also manages the business efficiently you may be able to collect annual dividends and live a financially comfortable life.
When you bootstrap or organically grow a company you have all the options in the world. You decide the speed, professional lifestyle, and how to reinvest or pocket any excess profits generated. But at the time a company raises VC funding you suddenly limit your company’s path into something where success is defined by large value creation. Expectations of rapid growth will overshadow most other things. In some cases you may also give up a bunch of control and freedom to your investors who suddenly can make a decision which goes against you around the strategic direction of the company and even your own job and function within the organization.
Understand your own drivers behind your entrepreneurial ambition and why you are choosing to create a new company, and recognize there are other paths and rewards to entrepreneurial success than raising VC funding.
2. Your market is simply not big enough
If you’re willing to give up control to pursue your opportunity, and you believe external capital will get you there faster, in order to be a likely candidate for VC funding you need to make sure your market (and ambition) is big enough. VCs invest with the potential of outside returns from companies who are true outliers when it comes to value creation. Fund economics is based upon power law distribution, where often one single company in a whole portfolio represents the vast amount of returns generated. The difficult thing for a VC is that it’s hard to know and predict which one that will be at the time of investing.
Hence, most VCs invests on the basis that every single investment must have a theoretical likelihood of becoming a huge outlier. The analysis done on how large a company could become (i.e. how much it can be valued at) is therefore often anchored in the underlying market opportunity. This comes down to answering basic questions like how many people or companies suffer from the problem the startup is trying to solve, and how much is the willingness to pay for such a solution. Unless the underlying market is multi-BUSD it’s unlikely VCs would invest in you. Keep in mind that often times your market is also smaller than you think it is.
To put this into perspective, at Creandum when I’m analyzing market opportunities, at a minimum I would like a single company to have a theoretical chance of returning a quarter of our fund. For a VC with a $200M fund, our investment would need to generate $50M proceeds for us. For simplicity of math, say the fund owns 10% at the time of exit, the company need to exit at a $500M valuation. This is the floor of the opportunity and most of the time we aspire to look for companies who pursue an opportunity sized far north from that.
The reality is that most companies are not going after large enough markets to generate this kind of value creation. We fairly quickly rule out companies which are pursuing a local, whether it’s a Swedish, or Nordic, or even European version of a well-known company category. Even if you do everything correct and win the market, a Swedish Netflix will not create enough value to generate the above returns.
Do the math, and in case you are not pursuing a large enough opportunity don’t pursue raising venture capital from institutional funds. There can still be local angels and alternative sources of financing which can be useful, if you really need money, but the VCs you read about on Techcrunch will shy away from you unless you can show a truly sizable upside potential.
3. You’re the superstar. Not the VC.
The VC industry is amazing at marketing. The story which is portrayed over and over is that from us you get “smart money”. Together with cash to invest into building out your company we also bring valuable advice, connections, and sometimes functional expert resources in areas like growth marketing, recruiting, sales development, etc. VCs are superheroes who have proprietary skills and resources entrepreneurs desperately need.
But let’s set the record straight. VCs will not make your business a success. And VCs oversell their value-add to entrepreneurs. In reality what VCs provide in ranking order is:
- Cash: The abilities for you (not the VC) to access financial resources which you can spend wisely in order to make your company grow faster and stronger.
- Quality validation: By securing VC funding you have had an independent professional investor evaluating your company’s product, team, and market and deemed it attractive enough to back. This third party validation creates a halo effect which will help you (not the VC) to easier hire talent, land customers, and (as we know from the intro of this article) get press coverage.
- Advice/connections/resources: Any good VC will surely give you valuable advice where they can reflect on previous experiences from companies overcoming similar challenges as you’re facing. And they may even have a network through which you eventually land a key client and/or hire. I’d like to think that me and my colleagues, in fact, do provide this to the companies we work with. This is all great but…
…the ultimate outcome of the company weighs on your shoulders and your abilities (not the VC’s). Successful companies are made because the entrepreneur is fantastic — not the VC. Successful companies are made because of amazing execution by the people who are deep in the trenches. Successful companies are made by entrepreneurs making the right micro-decisions every day, every hour, every minute. Strategic advice is easy. Execution is hard.
So don’t feel you need a VC in order to be successful. You are the superstar! Own it!
Final words
The only path of entrepreneurship is not what you read about on Techcrunch. Building your company independent gives you unlimited options. Don’t rush into the path of VC funding too soon, if you treasure your entrepreneurial freedom. And if you choose to still raise capital, make sure the opportunity is massive and have realistic expectations of what your investors can do for you. If you fit this script, feel free to reach out to me! 💪 👊