Saturday, February 23, 2008

Venture Capital is not the end goal

It’s interesting when talking to start-up CEOs and entrepreneurs how often they are enamored with landing venture capital, as if receiving the funding itself is their main business objective. Venture capital is the beginning of any start-up's journey- a vehicle to speed product development, expand market reach, and grow the firm more rapidly than what would be possible through self-funding from revenues. Venture capital is never the destination.

Just remember the VC's rough equation:

10 investments = 7 failures + 2 breakevens + 1 successful exit

You're one of ten - there's a better chance that you're one of the future failures in this model than the successful exit.

Just as bankers provide small business loans to firms that meet their expected rate of return hurdles, venture capitalists invest in start-ups that offer the opportunity for them to meet their own capital growth goals. This is not philanthropy. One rarely hears an entrepreneur express delight for their pending small business loan from their banker, yet closing a round of venture capital is met with valedictory celebration.

In many ways, it would seem logical that the bank loan should be the capital event to spark celebration at a small business, since the bank only wishes to be compensated with interest payments, instead of preferred shares. Of course, most start-ups don't fit the lending criteria of most banks - this is illustration is meant to offer some perspective.

Certainly venture funding is vitally important to fill the investment gap between angel investors, private equity, and traditional lenders. The start-up entreneur should just remember that there are two sides to any transaction. If a VC is willing to invest $5, $10, $15+ million in your biotech, software, or patented technology, that money will come at a cost. Be sure to weigh the cost/benefit of the transaction before considering venture capital funding to be the end game.

(There's some solid reading and perspective on venture capital and angel investing at The Smart Startup).


No comments: