The Tech Entrepreneur Road – To raise Venture Capital or not?
Sand Hill Road is a road in Menlo Park, California, notable for its concentration of venture capital companies.
Image credit: https://flic.kr/p/853kZ
Raising venture capital is like adding rocket fuel to your business. For most businesses this is not warranted, creates the wrong incentives and even if it was successful, the dilution resulting from multiple rounds of VC funding means that the founders do not make enough personal money when the business is ultimately sold.
- Raise a small round of capital: $20k – $200k from the three F’s (friends, family and fools)
- Use this to build a “good enough” product: sign up pilot customers, develop a scalable Business Model, and get your initial team in place
- Raise a round of angel money/ seed capital: $50k – $750k to further develop the product & a business model that really resonates with customers, so you start getting serious customer traction. Bear in mind that usually at this stage your company’s valuation is between $1 million and $3 million.
- Keep your burn rate Really low: (for the first year). Your goal is to prove to your investors and to yourself whether you really have a scalable business here
- Assess the situation in 1 year: For many businesses you will find that within a year you will know whether you can carve out a meaningful position in the market to build a small company. Many startup companies can get to 1-2 million run rate and are break-even somewhere within their first three years. This is fine. It creates options for you.
- At this point, there are two routes you can follow:
- Venture Capital Route: If you arrive at this point and you believe this can scale quickly to be a really big business ($50 – 100+ million in sales) then it is time to start thinking seriously about venture capital. I have come to know some entrepreneurs who have set their sights since day 1 to build businesses that will require VC – they have a huge idea and want to “go for it”. However, these cases are few and far between.
- Angel Route: The more likely situation is that you can see how to get your business from $1 million in sales this year to $3 million within 3 years and maybe $8 million within 5 years. If that is the case , then venture capital funding is not the right approach. Venture capitalists are not looking for companies that are doing $15 million in sales 8 years after their investment. In this scenario, a combination of bank debt and a small equity raise ($1-2 million) from high net-worth individuals/angels is more appropriate. Some of these people will find such a company to be an attractive investment. Venture capitalists would not be happy with this outcome; they want you to create a successful company that, upon exit, can return 10X to 40X of their investment.
So, obviously in the right circumstances and in the right amounts, venture capital money is the best way to scale. However, before that, you need a powerful product and a mega market to grab. Thanks SVASE for these wonderful insights!