Weighing the pros and cons of venture capital

No doubt you’ve followed the rise of billion dollar businesses that start from zero and exponentially grow in a few months. These companies are fueled by investments from venture capital firms.

Your next thought might be how your company — or team/concept/idea — can get plugged in to, what seems to be, a gushing pipeline of cash. But it may not be that easy or even desirable to engage VC.

How a VC thinks

VCs are professional investors with high expectations. A real estate investor would be happy with a 15 percent return on invested capital; a VC needs to have every company in which they invest have the potential for a 10 times return (or about 50 percent compound annual growth rate over seven years).

Even the best VCs have a third of their companies go out of business, so the winners need to support the rest of the portfolio. This severely limits the type of companies they fund. In fact, less than 2 percent of operating companies start with VC funding.

Why do you think you need VC funding?

A wise and honest VC I know says not to take VC money unless absolutely necessary, and then only for scaling sales.

Ask yourself from day one: Can you build, test, interview and market research your product yourself? Can your current team execute the business plan? Do you need to hire a computer developer, Web designer, etc.? Where’s the early money coming from — your savings, credit cards or home equity loan?

There are options at this point if you don’t have the ability to build it yourself or self-finance. Accelerators can provide early stage money with relatively low impact. It won’t be a lot (maybe from $20,000 to $50,000), but it’s enough to prove that your idea can scale.

The next stage is where it gets difficult. Do you have sales? If you’re still struggling to find that product market fit and the early-stage money is gone, then you need to assess the viability of your business. The key is to bootstrap as well you can; you need to get revenue in the door.

Now the question becomes, can you scale your sales by re-investing revenue. If yes, then it’s a matter of how fast you want to go — organic growth or VC investment?

It can be a marriage

The best VC will be partners in the long run that add strategic value by opening their rolodexes, helping with business development and finding key hires. The rest are taskmasters, de facto bosses, bean counters and generally a drag on your mental state.

If you have a business that scales and you’re in the position to accept VC money, then interview your investors as a long-term relationship, just as they are assessing you.

Overall VCs are a small part of the investment world, but if you have the right product, team and potential for explosive market growth then VC investment might be worth pursuing. There is nothing wrong, however, in following a path like 98 percent of successful businesses.

 

Todd Whittington is the managing partner of Lumos Innovation. Todd develops entrepreneurial acceleration and corporate innovation programs. He has had a winding career path focusing around innovation, processes, user acquisition marketing and operations improvement.