One of the hardest things in the venture business is to turn an entrepreneur down for funding, especially one that has invested time in building a relationship.It’s not fun to be on the receiving end of a “no” either, something we are reminded of when we raise capital for our funds.
Not every company should raise venture capital. Venture capital is expensive money. It comes with high expectations that can only be met with very absurdly rapid growth. And not every company can achieve hyper growth. Another way to look at it is that venture capital funds like betting on companies attacking very large and growing markets. This allows for a very high margin of error but also means that if the company is successful, that the value of the company is unbounded. Given the risk of these companies, a big payoff is the only way to get good expected values (and positive-NPV investment outcomes) from the portfolio.
A vast majority of companies– because of their target market, gross margins, the competitive landscape, the revenue model or other reasons– cannot achieve the dramatic growth that is expected of a venture investment. The second worst thing that these companies can do is try to raise capital and waste their precious time. The worst thing they can do is take venture capital and set up expectations they can’t achieve naturally. They will take on a financial partner who will become part of the decision making apparatus of the company whose expectations can never be met. Not a good situation for either side.
It’s important to recognize that these “VC-dropouts” can be incredible companies. Just because these companies cannot achieve hyper growth (> 100% a year), it does not preclude them from growing rapidly and creating a lot of equity value for the owners. Most importantly, without the expectation of professional capital, these companies can sell at much lower prices and have a life-changing financial outcome for the founders. The ability to sell at lower prices also means the companies will have many more options for an exit which increases the probability of a great financial outcome. For those that don’t get to exits, they can be run as lifestyle businesses that kick off a lot of cashflow indefinitely. Let the other companies that raise VC have the glory while you quietly enjoy your financial independence. It’s for these reasons that I often advise companies that fit the mold not to raise capital from me or any other venture investor. It may sound counter intuitive to tell someone not to buy the product I’m selling, but ultimately it’s the right thing to do for both of us. Not raising venture capital is not a failure for the vast majority of companies.
I’ll conclude with a metaphor: you wouldn’t want to put rocket fuel in the tank of a car. It’s going to make the car explode before it gets too far. Put less expensive regular fuel in it and you can drive it across the country and see great things. Put rocket fuel in a rocket and you have a chance to land on the moon but it’s really risky and it’s an all or nothing proposition. And you have to be committed to building a rocket, which is fraught with pitfalls, and consumes a great deal of time and capital. If you get to the moon, your picture will be in the paper and you’ll have a hero’s welcome. Driving across the country in a car that you can purchase tomorrow can provide a lot of memories without all the risk.