Do you really need VC?
Raising venture capital is perceived by many entrepreneurs (especially first-time founders and founders from emerging markets) as a victory in a startup race. But the reality is that attracting your first investment is the moment when fun times, times of complete freedom, end.
Disclaimer: This article is created not to turn you away from the VC world, but to ensure that you are aware of all the potential limitations and downsides VC investments are coming with. Venture capital, as well as investors’ expertise and network, can be extremely helpful for scaling your company but only if you take a meaningful approach to the fundraising process.
First of all, investment is primarily about additional responsibility. After you raise your first money your main target expands from building a great company to making your company a great investment for your VCs. It also limits your freedom — typically, they take board seats and most important decisions can not be made without your board’s permission.
Early-stage venture money is one of the most expensive funding sources. Why? It’s simply because the company’s early-stage valuation is always quite low, no matter how promising it is. Let’s have a look at a quick calculation of the real venture capital cost.
The bank credit interest rate is about 3–5% per annum. A successful startup, which gave an early investor a 15% equity stake at $1 million post-money valuation and then sold the company for $100 million in 5 years, in terms of the cost of money, attracted them at 150% per annum — more than 20 times higher!
Besides, attracting investment is a huge scope of work for the founders, distracting them from the main business. It usually takes a founder from 2 to 6 months of full-time work to raise an investment round. During this time, he or she has hundreds of meetings with potential investors and needs to be prepared for every single one. Also, do not forget the due diligence and round structuring procedures. Imagine how much time the whole process takes!
How to understand whether you really need investments or not?
That’s why before you start your race after venture money, you need to understand if you really need money, and in case you need it, do you need venture money or not. How can you do it? Read and analyze the following points carefully.
Bootstrapping vs Investments
As I’ve mentioned before, investment is all about extra responsibility and a decrease in potential personal profit in case of selling a company. So the initial question you should ask yourself is “Can I bootstrap?”
Bootstrapping is a process of growing a company without attracting external money, usually using founders’ savings and the company’s profits. The advantages of this approach are obvious — you are free to follow your vision and stay in tone (because you can invest only what you’ve earned). The main risk of this approach is the possibility that a competitor will raise a large round and will boost his growth. But such a strategy doesn’t work on all the markets, moreover, it works best on fairly competitive markets — the ones where startups should not go.
Such giants as ShutterStock, Atlassian, Dell, and GoPro followed the bootstrapping path.
If you decide that bootstrapping is not for you, you should clearly understand why you need to raise money. It’s better to go for funding when you already know how to make $10 out of $1. You should not only have a ready-to-sell product but also confirmed hypotheses on the market, target segments, and sales channels. Otherwise, you will face a great risk of using money ineffectively or even worse — multiplying mistakes. Don’t forget that money is just a catalyst for everything good and bad in a company.
Venture capital is all about multiple growths. Can you (and do you want to?) grow exponentially? Once you attract VC investments, you can’t just “jump out of the car” — investors are interested in high returns, you already have a commitment to do your best to generate it, so you have no choice but to grow at a rapid pace. If you need money, but you are not sure that you can and want to grow exponentially, you can consider other financial instruments, for example, loans, grants or venture debt.
And after all, are you ready to sell your company in 5–7 years? For many founders the company becomes almost like a child and parting with it can be a very painful experience. So keep in mind, that if you raise the money you will have no other choice, but to sell a company later (there is, of course, the option of a buyout, but it will cost you a ton of money).
Once again, this article is not about how bad VC is, it’s all about you taking a meaningful approach to the process of raising money. Anyway, clients who are happy to pay for your product are the best source of capital, whether you’ve raised capital or not. Deliver value and you’ll be rewarded. Or not. It’s a startup, baby.