When many entrepreneurs and business owners think about raising money, they think about venture capital. Unfortunately, most of these entrepreneurs don’t qualify for venture capital. As a result, they fail to raise it and are never able to launch or grow their ventures.
In fact, the number of firms who receive venture capital is incredibly low. According to PricewaterhouseCoopers and The National Venture Capital Association, in the last 12 months, only 3,199 U.S. companies raised money from venture capital firms.
So, why do entrepreneurs continue to seek venture capital, even when their chances of success are so low? I’ve found two key reasons. First, they are unaware of the vast number of other sources of funding they can access, such as crowdfunding, social lending, bank loans, vendor financing and others. And because they don’t know about these sources, venture capital becomes “the usual suspect.”
Secondly, venture capitalists dish out the big bucks. Those 3,199 companies I mentioned raised $21.8 billion (according to PricewaterhouseCoopers and The National Venture Capital Association). That’s an average of $6.8 million each. Seeing such big dollars, and the vision of what their businesses could achieve with them, can seduce even the most seasoned entrepreneur.
So why is the success rate for raising venture capital so low? Well, the No. 1 reason is that businesses that seek venture capital aren’t qualified. That’s not to say they will never qualify, because some companies just aren’t ready now. And it’s also not to say that they are bad companies, because the vast majority of successful and public companies did not raise nor would they have qualified to raise venture capital.
So what are the qualifications of a “venture-capital-worthy” company? The first key criterion is scalability or the potential for the company to achieve significant annual revenue, typically in excess of $50 million to $100 million within a five- to seven-year period.
The second criterion is barriers to entry. Barriers to entry are those things that make it difficult for another firm to compete against you, such as patents or proprietary technology, a unique location, and long-term customer contracts.
The third criterion is having a strong management team. This is because most venture capitalists realize that the people running the companies and not the product or service itself will ultimately cause the company’s success or failure.
The fourth criterion is that venture capitalists need to feel confident of the company’s exit strategy, mainly that the chances are good of eventually having another firm purchase it or the company going public. This is because venture capitalists take equity in companies and only “cash out” when there is an exit or liquidity event.
The final criterion is that a company meets the sector, stage and geographic criteria of the specific venture capital firm that it is targeting. For example, some venture capital firms will only invest in health care companies, some will only invest in companies that have first achieved customer traction, and many will only invest in companies located within 100 to 200 miles of them.
While the overall success rate of raising venture capital is terribly low as stated above, when you weed out the entrepreneurs who don’t meet these criteria, the rate goes up substantially.
That’s not to say that it’s ever easy to raise venture capital, since the process is extremely arduous and often takes six to nine months of continual work. But by targeting only the venture capital firms for which you are qualified, and methodically working through the process, you can raise venture capital.
Dave Lavinsky is the president and co-founder of Growthink (www.growthink.com). Since 1999, Growthink has helped thousands of entrepreneurs and business owners develop business plans and raise numerous forms of financing, from bank loans to venture capital and private equity transactions. Lavinsky can be reached at email@example.com.
Are you looking for equity investors to grow your business?
If so, I hope you’re not walking around wondering where you can find these investors. Because they’re pretty much everywhere.
Let me explain.
To begin, there are two main types of investors: individual investors and institutional investors.
Individual investors are investors who invest their own money in companies. They are better known as “angel investors.” Institutional investors, on the other hand, are investors who invest their company’s or other people’s money. The largest class of institutional investors for entrepreneurs are known as “venture capitalists.”
Now, the vast majority of entrepreneurs should be seeking angel investors and not funding from venture capitalists. Why? To begin, most venture capitalists won’t invest less than $2 million in a company, which is often too much money for a startup and would cause the entrepreneur to give away too much control of his company. And most venture capitalists won’t invest in companies unless they have already accomplished several milestones (such as having a developed a product, having secured customers, etc.). That’s why many venture capitalists fund companies who have raised angel funding first.
So, while venture capital might be perfect for an entrepreneur later, in most cases, the entrepreneur needs to first raise angel funding. The good news is that it’s much easier to raise angel funding than venture capital funding. According to the National Venture Capital Association, only 2,893 companies raised venture capital last year. On the other hand, according to the Center for Venture Research, 57,225 companies received angel funding. That’s 20 times the number of companies who raised venture capital.
In addition, those 57,225 companies were funded by 259,480 individual angel investors. And further, those 259,480 individual angels are just a tiny fraction of the total number of investors that can provide funding to entrepreneurs.
In fact, according to The Spectrem Group, there are 980,000 U.S. households with a net worth exceeding $5 million and 7.8 million U.S. households with a net worth exceeding $1 million (both figures exclude the value of the household’s primary residence).
That’s millions of potential angel investors. And the best part for entrepreneurs is that these are mostly “latent” angel investors. That means they don’t look at themselves or call themselves angel investors. And they don’t get bombarded with companies to fund. But, they have the means, ability and often interest in investing in entrepreneurs and emerging companies.
And why wouldn’t they? Virtually all of these investors have money in the public stock markets, which have provided flat or negative returns over the past 10 years, while over the same time, angel investments have earned an average of 27 percent annual returns.
So entrepreneurs are actually doing these investors a favor by having them invest in their businesses (if their businesses are solid, of course).
As you might imagine, most of the millions of latent angels in the United States can be easily targeted. They tend to live in certain ZIP codes. And the primary breadwinners are typically business owners and executives who are on multiple lists that an entrepreneur in need of funding can purchase.
A word of caution to the entrepreneur, however, is that the selling of securities in your venture is regulated by the Securities & Exchange Commission. So it is strongly recommended that you use appropriate legal counsel and follow the proper guidelines when raising angel funding.
But once again, the good news is that angel funding is all around you and is accessible to entrepreneurs with a solid business idea and plan.
Dave Lavinsky is the president and co-founder of Growthink (http://www.growthink.com). Since 1999, Growthink has helped thousands of entrepreneurs and business owners develop business plans and raise numerous forms of financing. He can be reached at firstname.lastname@example.org.
In 1957, retired Gen. Georges Doriot invested $70,000 in a start-up named Digital Equipment Corp. Well, that $70,000 turned into $355 million. And when others found out about that, they started investing, too, and the venture capital industry was formed.
But while thousands of entrepreneurs have raised billions of venture capital dollars since then, the vast majority of entrepreneurs have failed to raise venture capital.
There are two key reasons for this. First, most entrepreneurs don’t qualify for venture capital since they can’t scale fast enough, nor do they have the potential for a large enough exit. And second, there are too few venture capitalists versus the masses of entrepreneurs who need money.
Fortunately for entrepreneurs, a new type of funding recently emerged called “crowdfunding.” Crowdfunding turns the tables, because there are now more potential investors than entrepreneurs.
Crowdfunding is when a group of people collectively fund a cause. That cause could range from paying for medical bills or a wedding to filming a movie or starting or growing a business.
To an extent, crowdfunding has been around forever and is the basis for most nonprofit fundraisers.
But due to the recent advent of two Internet platforms, business crowdfunding, or using crowdfunding to fund a for-profit business venture, has started to take off.
The two Internet platforms are Kickstarter.com and RocketHub.com. Each allows entrepreneurs to raise crowdfunding for their for-profit ventures (nonprofit ventures can also use them).
In brief, these platforms allow entrepreneurs to post their funding requests. They also handle all the funding transactions. The process works as follows: Entrepreneurs start by creating a video and/or text about what their venture is all about. Then, they establish the amount of money they need to raise and over what time period. Next, they set rewards for the donors. For example, for a donation of $25, donors may get a company T-shirt. Or donors giving $100 or more may get a $50 gift certificate to use once the business is open. All of this information is posted on the entrepreneur’s page on the crowdfunding platform.
The final step is for the entrepreneur to tell the world about his or her crowdfunding request in order to get people to donate. This is where it gets interesting. Crowdfunding is taking off because spreading the word about yourself or your venture is so much easier today than it ever was before.
For example, by using tools like Facebook, Twitter, YouTube and e-mail, infused with entrepreneurial creativity (e.g., creating intriguing/viral videos about your business) entrepreneurs can quickly gain awareness and support from hundreds, thousands and even tens or hundreds of thousands of people.
For example, in early 2010, four New York University students started a social networking company called Diaspora. The students posted their crowdfunding request in April 2010 on Kickstarter.com and raised $200,642 from 6,479 people, most of whom they’ve never met.
Diaspora, with its $200,642 crowdfunding round, has raised the bar for crowdfunding. Formerly, most companies raised between $5,000 and $25,000 from this method. But the average amount raised should continue to increase as entrepreneurs hone their ability to tell the masses about their ventures.
Both Kickstarter.com and RocketHub.com are reward-based crowdfunding platforms, which means that donors receive rewards for giving, even if the value of the reward is less than the amount of their donation.
Debt-based crowdfunding platforms, also known as social lending, are also available via websites such as Prosper.com and LendingClub.com. On these sites, entrepreneurs can request business loans from individuals rather than banks.
And, finally, there is equity-based crowdfunding, whereby funders give money in return for equity. This type of crowdfunding has not yet taken off due to the complexities of equity transactions. However, several entrepreneurs are working on solutions to this problem, and I expect that soon such a platform will exist.
The Internet, e-mail and social networking sites have allowed most of us to build larger networks of friends and colleagues and to interact with them more easily and frequently. Crowdfunding allows us to leverage these tools and connections into funding for new and growing business ventures. It is a unique form of funding that is appropriate for most entrepreneurs and is relatively quick and easy to raise. As such, most entrepreneurs should start tapping this new funding source immediately.
David Lavinsky is president and co-founder of Growthink (www.growthink.com). Since 1999, Growthink has helped thousands of entrepreneurs and business owners develop business plans and raise numerous forms of financing, from bank loans to venture capital and private equity transactions. Lavinsky can be reached at email@example.com.