Venture Capital – It’s Not “Welfare” for Start-up Companies

Most of the time, when I first meet with entrepreneurs and their start-up companies, they are usually focused on the money they think they “need” to make themselves successful. More often than not they say, “If I just had a $1.0M to get my company off the ground that would solve all my problems.” This “money-focused” mentality often makes these same entrepreneurs take their eye off their real objective — making their company an attractive investment opportunity for potential investors. As I always tell them – “money never solves your problems, either in your personal life or in business, but being prepared, focusing on your company and securing customers will.”

Venture Capitalist focus on the “Best in Class” Investment Opportunities

Venture capitalists and other private equity investors, by the nature of their business, are “risk adverse” and not “risk takers”. This line of thinking seems to escape entrepreneurs and their start-up companies. This is especially true for “first-time” entrepreneurs. These individuals do not take the time to look at their start-up company and its associated “investment risk”, from the venture capitalists point of view.

A venture capitalist has a fixed amount of money in their private equity fund. This fixed sum is used to invest in a limited number of companies over a given period, usually 7 to 10 years. With these limited number of investments, the venture capitalists and their funding sources (e.g. pension funds, private individuals, etc.) know that a number of them will fail, a number of them will break even or do a bit better, and a couple will be highly successful. Therefore, from their point of view, venture capitalists are taking a traditional “portfolio management” approach to minimizing the inherent “risk” of their individual investments. As such, venture capitalists only look for the “best-in-class” investment opportunities to ensure that their “portfolio risk” is minimized and their individual investments succeed over the life time of their investment fund.

Not all Companies are Candidates for Venture Funding

All of the entrepreneurs I meet believe that their companies are fundable by third-party equity investors, be it angel investors, venture capitalists or other private equity sources. The truth is that very few of these same companies will be able to secure monies from these same funding sources. The statistics show that only about 3% of start-up companies, which are reviewed annually by venture capitalists, secure funding from these same funding sources. Therefore, it is not hard to believe that the other 97% are either not fundable or have to secure funding from other sources (boot strap, friends and family, etc.).

As an example, recently, I received a request to help secure funding for a start-up company that was looking to develop a service offering addressing a new, bleeding-edge market that had yet to develop. They were looking for $1.0M in investment capital, but were only projecting $5.0M in revenue in their fifth year of operations. This company is clearly not a candidate for venture capital or any other third party equity funding. On the other hand, suffice it to say, that if a company, at some point, succeeds in generating revenue of $5.0M a year, with high gross margins, this will end up being a fine “life-style” company for its founders. This type of start-up company and investment opportunity is not a bad deal for the founding team over the long term, but is definitely not a candidate for third-party equity investors.

Start-up Companies are in Business to Secure Customers

As a start-up company, entrepreneurs need to remember that they are in business to secure customers and not just to develop a technology, or service offering. By focusing on securing customers early on, these same start-up companies will provide substantial benefits to themselves in both the short and the long runs. In the short run, the start-up company will have demonstrated to potential investors that there is a “market need” for its product and that customers are willing to pay for it. This is very attractive to investors as it reduces their investment risk and demonstrates the potential for market traction. Also, by securing customers early, this will provide this same start-up company with a “lead” customer. This is often key to securing long-term success in the market. A lead customer will help drive a start-up company’s technology, product or service features, functions and capabilities. This is very important to a start-up company’s success in the market, as end customers always know more about the market application requirements than the start-up company developing the technology. Finally, by securing customers early, this will allow a start-up company to generate revenue. This will reduce both the start-up company’s short term and long term capital needs, requiring the founders to give up less equity over the long term.

Planning, Preparation and Securing Customers is the Best Plan for Receiving Funding from Venture Capitalists

Entrepreneurs should not expect that angel investors, venture capitalists or other private equity investors will provide them with money, just because they have an idea. This is an unrealistic expectation. Entrepreneurs need to work hard in planning and preparing themselves and their company to be ready to present their investment opportunity to potential investors. Remember, venture capital is not “welfare” money for start-up companies. Investors are looking to secure a significant return on their investments in a predictable time period. If an entrepreneur and their start-up company do not offer, as a minimum, the following, it will most likely not secure funding.

•  A “best-in-class” team,
• A disruptive technology, product or service offering,
• A sustainable long-term competitive advantage in the market,
• The ability to secure customers and market traction,
• A proven business model, and
• The ability to scale and dominate the target market(s) of interest.

So, as an entrepreneur, focus on your start-up company. Take the time to plan and prepare yourself and your start-up company for the rigors of securing funding in this tough environment. This includes securing customers as early as possible. This will substantially increase your odds of securing funding and make your start-up company a much more attractive investment opportunity for venture capitalists or other private equity investors.

The information outlined in this article comes from my new book entitled “Business Planning, Business Plans and Venture Funding – A Definitive Reference Guide for Start-up companies.” Signed copies of this book are available at http://www.carlsbadpublishing.com. Robert also provides business planning, and venture funding consulting services to start-up, small and mid-sized companies.