People have different definitions of “startup” and “venture capital,” and it’s that foundation that causes frustrations and misplaced expectations.
What Frustrations in Venture Capital?
- The real reason founders are not funded VCs don’t say in a pitch process
- Why Venture Capitalists Aren’t Funding The Businesses We Need
- VCs like to take their time with their decisions because it’s a good idea to do so
- Why don’t more VCs care about good tech?
I ran a quick query on my favorite Q&A site, Quora, and found a litany of similar questions:
- Why don’t investors fund more movies?
- Why don’t VCs fund traditional profit making businesses in India to help them scale up?
- Do VCs fund nonprofits? If not, how else could they get funded from private investors?
The gist of the theme we’re seeing is that people are disappointed that VCs aren’t interested in their thing. And that’s spurring disdain toward, and misconceptions about, Venture Capital; aggravation that we might explore a bit more, to help alleviate and better direct everyone’s focus toward meaningful connections.
In MediaTech Ventures, our most popular article is Venture Capital Firm Investment in Entertainment Companies, reinforcing for me anyway, that people the world over are trying to figure out why investors aren’t engaging, and how to better raise capital.
And with all that in mind, it dawned, that to a very great extent, it isn’t that you need more customers, a better pitch, or some other evidence of a good business, it’s that we’re seeking funding from the wrong sources of capital.
Think of all the Capital in the World as Being Isolated in One Hypothetical Company
This is a thought exercise; a way to change our perceptions and expectations. So play along, imagine if our entire economy was ONE big company and that everything we do and everything we have exists within that company.
VC is a target in recent years. “Why won’t it fund my new business??” “It doesn’t like profitable, sustainable ventures, WTF??”
I’m paraphrasing of course; the point is that there is the ire toward certain forms of capital because it inexplicably doesn’t fund otherwise successful things. Fair? So here’s our notion: Think of that company, everything we all do has a correlation between With The Company vs. Otherwise Reality
Consider (oversimplifying of course) that our company has money allocated to 4 distinct things:
- Operations: employees and licenses, supplies, etc. – the stuff needed to exist
- Growth and optimization: marketing, developers, promotions – the budgets allocated to become more
- Innovation and R&D: research and development, experiments, design, trials – the investment companies make in completely new things
- Mergers & Acquisitions: acquiring small businesses, legal expenses to merge – consider the expenses incurred when companies make major changes
Thought exercise. With me so far?
Your work, your venture, draws resources from one or more of those sources.
To appreciate the role of Venture Capital, we look at the purpose and expectations of capital sources for each of these cases as though it were reality and not our isolated company:
- Operating expenses and employees for our company funded akin to a Bank Loan. We know how the money is used, for what, and our operation drives measurable revenue – Money out / money in.
- Marketing and development budgets are *business investments.* We’re putting money into something, knowing what to expect but not directly driving revenue. We’re investing in the business. And while we use the word “investing,” this isn’t the same as Venture Capital investment because our allocations to development or marketing are typical, familiar, and with expected results. This is what you’d get from a business investor, partner, or in something like revenue based financing.
- Our company’s Research & Development is fueled by Venture Capital. We don’t know if it will work, we don’t have or know the model. We have to invest in a great many tests, experiments, and endeavors that will fail, if we’re to uncover that which might work. We’re funding possibilities.
- M&A (Mergers & Acquisitions) is Private Equity. Our company has cash on hand, equity, and other assets, and we can use that to do massive things with organizations.
Why doesn’t Venture Capital fund the profitable business? That’s not its role. That’s not its purpose.
Frustration or expectation is misplaced IF and WHEN we’re developing or operating a business that isn’t suited to Venture Capital. VC funds the experimentation of our economy.
Agreed. Generally speaking, most of the people complaining bout VC are generally unaware of its M.O. VCs place bets on outsized risk and reward opportunities. If you want to start an accounting practice (Likely profitable from Day 1) then your funding must come from sources comfortable with average returns.
Craig Barrett thank you. yes. this
That assumes VC’s are actually funding ‘R&D’ related opportunities and taking risks. BUT my observation & experience is that VCs want ‘startups’ to have traction- sales, customers, and show other business metrics- this isn’t investing in R&D this is investing in semi-known business and revenue models. Angels investment is more aligned with R&D investment than today’s VC. Silicon Valley VC’s ‘back in the day’ had a much different attitude.
Dennis Lyftogt “VC” in name or VC actually?
My experience (on the coasts, granted) is that VCs aren’t seeking sales, customers, etc. And yet too, yes, here, they tend to be.
So is it accurate to call them all the same thing when they actually operate differently? Is an “investor” seeking a business with revenues actually not just a business investor? Nothing wrong with that… but what distinguishing the high risk investment, without revenue, from the investment in an operating new business?
Agree, I’ve seen both faces…when i started a 3d laser company 2001/2..i sent biz plan for $3m to a well known sandhill road vc, and they said “spice it up, add the words internet, ask for $30m, and it will go through”… i really like the idea of 30m, but couldn’t as i had no idea what to do with $30m, the pound of flesh it had to come with, and what would internet would do with a 3d laser in 2002-2007 time frame…then i got a Norwegian fund to back it, for the 3, who wanted risk growth but no crazy…worked out better for all concerned.
I think expectations are based on the round, and the type of investor (angel, vc, trust, etc…). With VC’s who usually come in after seed, they’ll typically expect some traction. Revenue and profit? That doesn’t matter, as long as you are going to be big.
When I think of vc I think higher risk, quicker payout. Whether they are taking that risk on early stage development, or a more developed company will grow at a certain pace.
agree…risk and reward, whatever its moniker may be is different from growing and cash flow investing/bankers
Great insight! ?
Thats why we bootstrapped it until people saw the industry breaking vision that we created. A new social side of things.
Hell we may even bootstrap it all the way through lol.
But yeah when we pitched most loved the idea but it wasn’t in their sector.
I think for most startups like myself is finding the sector investors which is hader because they say (let say health tech) but then state not their sector. That made it a bit challenging but also help us grow to be 100% debt and 100% owned as of now.
This is a great post.. I would LOVE one to explain finding the correct sectors
I like it.
Will even add to the pile, I’ve caught myself referring to my own 10 year old company as a startup. I guess it’s like how we still call adult children our babies.
(also, “its”, not “it’s”)
I think the disconnect is due to the definition of startup. “Startup” has started to encompass any sort of entrepreneurial endeavor. VCs/PEs of the world are looking for startups in the more technical sense.
I think it was Steve Blank that simplified the definition to something like, startups are a temporary organization in search of an exit. (I’m paraphrasing, don’t quote me.)
That exit, whether acquision or IPO, is what pays VCs/PEs. They want to 10x+ their investment in a relatively short period of time. A sustainable or profitable business doesn’t create that opportunity in that limited timeframe.
S. David Ramirez Blank’s definition is my most cited, and I find it the most accurate, over all time ?
It’s not “technology” – whether internet enabled, SaaS, or CPG: is it a temporary venture searching for the business model? Then it’s a startup.
Paul O’Brien Why use the word “temporary”? It seems that *any* organization that can be a vehicle for a big exit is fair game. The point that the VC’s inject their ownership is the point that it “starts” for them. Prior to that, it really doesn’t matter what the company was, did, by who, or for how long. The startup date is the portfolio date and is a sort of rebirth.
My recent distillation of this thought process is very much in alignment with yours, when originally it wasn’t. A year ago when I set out to launch my “startup” I thought I was going to be “smart” and bring all my internet marketing friends in and build revenue in a company along the way, doing both what I know to be true of selling “content” along with developing the technology behind it. I was originally stuck in my conversations however and quickly realized trying to describe my big vision people would get lost in the weeds of my short term revenue business plan. People want to see and feel the big vision, they want to get excited about massive game changing potential, and this is what I know see as the whole goal of talking to VC’s. They don’t really care about another 30 million dollar business, they want to see the next billion and even trillion dollar potential. and you should for sure get outside and experience the cold. Breathe in and out through the nose and find a peaceful area to settle into. It’s a massive game change for your mental health. Having contrast in our environment and accepting it for what it is, allows for the nervous system to find balance which then allows for more gratitude to happen.
I think the distinction is appropriation of risk. Venture is 10x high risk, most likely to fail, but asymmetric upside on success. Growth equity is fuel on cac:ltv ratio that is working. Loan or more likely friend and family raise is the opportunity for higher % than traditional market. You may have an incredibly profitable company that wont get to the scale multiple that VC needs for their LPs. I believe there is the right capital vehicle for every situation but the problem is naïvety of Twitter followers and TechCrunch readers vs market reality
I like this approach. VCs are targeting a specific types of massive upside companies, because the math works for them and their investors. If you don’t fit their model – you won’t raise $ from them. Its that simple.
If you have a profitable business though, bank loans are WAY cheaper and you don’t have someone on your board clamoring for you to go faster, faster, faster. That’s a blessing. Count your lucky stars imo.
It’s VC not PE ?
Richard MacKinnon Great question
I think you’re blending two different notions though. Why does “startup” use the word temporary? And, can’t anything primed for a big exit be fair game to investors?
Yes, in the second case. That doesn’t have to be a “startup”
Why does “startup” use the word temporary? Because at some point, it becomes an operating business or company.
That is, that a typical new business is just that, a new business. A startup isn’t necessarily a new business: it could be nothing more than an effort to build a product, it could be a push to be an enterprise company, or remain a small business. In any event, since the business model is not yet known by such entities, since they’re in search of a business model, they’re temporary, until they either fail or figure it out.
I’m going to say way off. Every investor is different. They can call themselves a VC but doesn’t necessarily mean they are or think like an angel. Take a number. Roll the dice. All semantics. Try selling something. If not and you truly need capital then raise just that and get one customer. Better yet, ask the market first then build.
Michael J Gilbert so way off…. but you blended VC and Angel, I didn’t ? I don’t consider Angels to be VCs nor are VCs, Angels. And I find most agree with that sentiment; VCs manage funds and other investors’ capital. Angels are individuals deploying their own capital.
This topic amuses me. When I was a part of CTAN it was somewhat of a pejorative to be labeled a “lifestyle business.” When you probed about what this meant the answer seemed to be anything that did not fit the canned model that the investor was seeking and thus should be shunned or scoffed at.
I also distinctly remember going to a poker party that was hosted by a local company with many VCs present and one of their junior associate bragging about “recapping the shit” out of some company. After already having quite the distaste for venture capitalists this didn’t help a whole lot.
Given the commentary above I am not sure that it matters a whole lot what the risk/return profile is for the company. To me everything in the strike zone for an angel or a VC is an operating entity and not something more project-based like a real estate development company. A company can be “starting up” and intending to be a lifestyle company, bootstrapped, or funded any number of other ways. The fact that funding entities like VCs have a narrow lens they view the world through doesn’t given them some monopoly on the use of the term “startup.” To me startup can apply equally to any number of companies regardless of funding source.
Regarding a mismatch in perception of what a VC *should* do that has a lot to do with founders not understanding how capital forms and how risky their concern really is. It equally applies to the VC firm trying to turn every object into a nail when all they have is a hammer to work with. I’m not sure how this rift will ever be addressed when people on both sides are so willing to avoid assuming the reference frame of the other or of educating themselves. From my observations these tend to be pretty distinct camps and the money fails to understand the struggle of the founder(s) every bit as much as the founder(s) don’t understand the capital formation process and risk inherent in investing in something unproven.
Great explanation Paul O’Brien, the analogies in your article make alot of sense.
Cheers Milly Tamati. Just a different way of looking at things. Greatly appreciate hearing that it helped some!
Paul O’Brien I hear you and understand that. I was saying that once a VC injects capital/talent/support into any organization, they are essentially re-starting it (from their perspective) on a new high octane trajectory designed to transform that organization into a high stakes investment vehicle. Oftentimes, this re-started organization ends up bearing little resemblance to what it was and oftentimes, it explodes under stress.
Richard MacKinnon wonderful point. One of my favorite cited stats, with early or first time founders in the incubators, is that we all know the 90% of startups fail conventional wisdom… did you know that 74% of funded startups still fail? Funding isn’t an assurance, it’s just a resource with it’s own respective cost.
I dig where you’re going with this… I think a discussion with our VC friends would be great to share opinions and swap ideas here!
Cheers John P. Garrett. Was on Pflugerville today, saw the Community Impact Newspaper buildings; gorgeous. Let’s connect this week and talk Round Rock, yeah?
Paul O’Brien sounds great
And if those same founders knew the funding stats and their slim chances of getting funded – how many would have :
Started in the first place ?
Wasted all that time seeking funding instead of growing the business organically and actually proving that you CAN do it ?
Just asking ………..
Gem stone from @seobrien – a great read!
Founders also ask far too much in valuations and fail to realise the very high risk early stage investors are taking.
After a while you realize its actually easier and far more productive to work on getting a “Yes” from your prospective clients and customers then spending time on investors.
Great read. With us raising our seed round at $14mm valuation. This is a great read definitely on VC funding.
Thanks, finally get what I was looking for, now I will put into on this.
Is this this like #WTF ! What the fund ! VC’s are like medical specialists you don’t go see a dentist when you’ve got a sprained ankle
That’s a wonderful way of thinking about it; that it is like healthcare in as much as an Angel, a Corporate VC, a Venture Capitalist, and a Business Investor are NOT the same, they’re Specialists.
The podiatrist won’t treat your chicken pox