So many tech entrepreneurs believe that after getting an idea, building a prototype and hopefully getting some early traction, raising Venture Capital is the next step. VC’s have pushed that message for years as a way to get deal flow, and they’ve done an excellent marketing job, so it’s hardly surprising that raising VC is seen as one a step on the journey, not an optional route.
Companies that don’t raise capital and succeed and lauded as outlier successes — ‘how did they do it without burning loads of money?’! To the rest of the world — this mentality is hard to comprehend. The vast majority of businesses are required to be scrappy and grow from cash-flow, profitability, and the odd bit of bank debt.
Raising venture capital is massively time consuming and a huge distraction from running the business, and really not required or suitable for most of the companies that do raise it (or try to). The reality is that the vast majority of software startups today should not raise any money (outside of maybe a friends and family kick-start); yet the majority do. In a market that is incredible capital efficient, where the cost of building and promoting a new company is close to zero, this is a sad irony.
Once you raise VC you are on a very specific, high-risk path. It’s a push for fast-growth, win-at-all-costs, lead or die game. Outside of the consumer world, this is not the case in the real business world.
The VC wants their investments to be huge wins, and anything other than a 10x return at least is not of interest. The model is based on buying lottery tickets — the winners are few but deliver astounding returns, the failures are many (and that’s okay, it’s the VC model, but you can be sure 9 out of 10 people raising VC don’t think they are the 90%,!) and I would argue many failures are not business failures, but failures because the company was pushed onto the VC gravy train and lost focus on building real business.
How many entrepreneurs really think about that when they are on their fund raising quest? If most were honest I think they would be happy with much smaller levels of success that what the ‘Silicon Valley Pitch Deck’ requires.
What is the VC gravy train? First of all — no company raises money once and succeeds from there, once you start, you keep raising. VC’s need returns — big wins — so they are going to push you to grow, and grow fast — which means spending out ahead the company’s logical needs.
Once you start hiring and spending, there’s no going back. You’re going to need more money to keep spending at the pace you need to grow. Net profit or positive cash flow are not the light at the end of the tunnel — that light is the real world train coming to hit you when you miss a growth target and can’t raise any more money. Kaboom — the gravy train is gone. The VC’s will be okay, don’t worry, they have lots of gravy trains. The founders only have one.
Do this sense check when you’re starting out: is your company going to raise $10’s of millions, grow to $100m revenue and potentially go public? Does your company really honestly need a lot of capital to get started and grow? Can you tolerate a 10% chance of success? Raise VC.
Or — is your company a solid business you are passionate about and you’re going to work super hard to execute on? Will you be happy if it generates revenue and sensibly grows to profitability and then keeps growing? Are you a success if you own all the equity and have control? Build a Real Business.
(If anyone is interested in the context of this post — it’s that at Scaleworks we see a lot of good businesses that are effectively being wound down because their cap table and economics (not their unit economics) were structured expecting a much different outcome. We’ve seen businesses with $10m+ in revenue and strong growth go into foreclosure because the debt burden alone was not serviceable. No one makes money in these situations but the fundamentals of the business itself are often sound.