My idle thoughts on tech startups
Reasons NOT to take venture capital…
As a VC, I get to meet a wide range of entrepreneurs. I personally derive meaningful psychic rewards from engaging with entrepreneurs on a daily basis. Having been part of building two companies I can appreciate the challenges they face, but perhaps more importantly I remain in awe of the passion and commitment to their cause nearly all entrepreneurs possess (both the successful ones and the not yet successful).
That being said, not every startup should pursue venture capital funding. I figured I’d do a two-part post here, starting with the “con” case but then following-up with the “pro” case as well. Or more accurately, try to outline scenarios where entrepreneurs are probably better off if they don’t end up raising VC money. These scenarios almost always come down to a misalignment of expectations. Startups that are also very very early in their development may also have to wait to raise VC funding even if they are ultimately a good fit, and “stage” is relative based on sector (i.e. “early” means different things in consumer internet, cleantech, medical devices, etc).
Expectations of Control
If as a founding team, you want to maintain absolute and final control over all aspects of the company then you probably would dislike working with VCs. Of course venture capitalists as a group are often perceived as overbearing control freaks, and there are certainly those among us who are in reality overbearing control freaks. But generally speaking VCs end up owning a minority of a company, so to be good stewards of the millions of dollars we invest (on behalf of ourselves and our limited partner investors) we seek to have some level of influence by virtue of owning preferred shares, certain protective provisions, board seats, and the like.
Expectations of Outcome
An entrepreneur (or small team of entrepreneurs) could start a company from scratch, build an interesting product an perhaps initial revenue stream, and sell the company for $20M. Personally, I think this is an outstanding outcome and I take my hat off to the countless entrepreneurs who’ve done something very similar to this. Assuming the entrepreneur owned a substantial portion of the company, that would be a great outcome not just financially but also as a benchmark of their own abilities. But VCs are interested in building big companies, that can achieve substantial revenues (e.g. tens or hundreds of millions) and exits of $100M+ or even $1B or more depending on the size of their fund. If that sort of outcome is infeasible (e.g. your market opportunity is modest sized) or differs from an entrepreneur’s definition of success, VC funding is unlikely… and that’s ok.
Expectations of Pace
VC’s typically want to invest in markets that have solid growth, in businesses that can scale quickly, and in teams prepared to do nearly whatever it takes to achieve that scale with their startup. Why? Because investing in these markets, and in businesses that are based upon or leveraged by technology has proven to be the best way to build big companies. Mature, slower growing markets typically have entrenched competitors that are difficult to displace. And businesses that scale by virtue of adding significant human inputs (say a hospital or restaurant) or capital intensive infrastructure (think your power company here) usually don’t generate massive returns on equity capital commensurate with the risks of investing in early stage startups.
Fundamentally I make no value judgment over whether pursuing VC funding is a “bad” or “good” thing. There have been a ton of immensely successful entrepreneurs who’ve built companies in collaboration with venture capital backers. And there have equally been a ton of immensely successful entrepreneurs who’ve built companies without raising a dime from VCs. I frequently encounter entrepreneurs who automatically assume they should raise VC funding, so I simply want to highlight situations where it may not be appropriate.