Do You Really Even Need Venture Capital?

I recently spoke on a panel in Santa Monica organized by my friend Jason Nazar, CEO of DocStoc, titled Startups Uncensored, Pitching Venture Capitalists. There were about 200 people in the audience.

Jason started by asking the audience how many of them were start-ups — 90% of the hands went up. He then asked for a show of hands of people who had already raised a round of Venture Capital — no hands. I guess you’re thinking, “duh, that’s why they came to the panel discussion.” 😉

He next asked me specifically how many of these companies were likely to get VC funding (thanks, Jason) and I responded, “less than 5%,” to which I heard a big gasp. I responded that I thought this was a good thing — not something nasty. I contend that the vast majority of companies should never raise venture capital.Raising venture capital is like adding rocket fuel to your business and for most businesses this a) isn’t warranted b) creates the wrong incentives and c) even if it is successful means that the founders don’t make enough personal money when the ultimate business is sold.

I repeat this advice on a very frequent basis to most entrepreneurs I meet and I find it usually surprises people. “You’re a VC — aren’t you supposed to want to give us money?” No. I want you to create a successful company that will be fulfilling to you and your employees and will make life better, faster and easier for your customers.

I also want you to make a great deal of money when you sell the company one day (or pay yourself great annual dividends to be paid out at a lower tax rate than you pay for your salary). A banker once told me that he was surprised how many $50+ million exits where the founders made very little money.

For most tech entrepreneurs my advice is:

  1. Raise a very small round of capital — usually from angels or from the three F’s (friends, family & fools): $100–200k
  2. Use this to get a product built, sign up pilot customers and get your initial team in place
  3. Raise a round of angel money / seed capital: $250k-$750k.
  4. Keep your burn rate REALLY low for the first year. Your goal if to prove to your investors and to yourself whether you have a scalable business here
  5. Assess the situation in 1 year. For many businesses you will find that within 15 months into your operations you will know whether you can carve out a meaningful position in the market to build a small company. I see so many companies that get to $1–2 million run rate and are break-even somewhere within their first three years. This is fine. It creates options for you.
  6. 6a. VC Route — If you arrive at this point and you believe this can be a really big business ($50–100+ million in sales) then it’s time to start thinking seriously about VC. Awesome. I know that some people know from day 1 that they’re building businesses that will require VC — they have a huge idea and want to “go for it.” I accept that this is sometimes the case. But it is rare.
6b. Angel Route — If you’re in the more likely situation that you can see how to get your business from $1 million this year to $3 million within 3 years and maybe $8 million within 5 years then VC may not be for you. VC’s aren’t looking for companies that are doing $15 million in sales in 8 years from their investment. In this scenario I advocate a combination of bank debt, venture debt, small equity raise ($1–2 million) from high net-worth individuals. These people would be thrilled with a company that could potentially double or triple their money. VC’s would not be happy with this outcome.

Shouldn’t most businesses at least TRY to go out and raise VC if they could? No. (…)

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