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About VC Money and Startups

By : Ziad K Abdelnour| 2 February 2015
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Having been in the VC/Private Equity business for three decades now I am often asked if VC money can make a startup successful on its own and if not what really does it.

So I thought I’d share with you in here my 2 cents in the hope of further educating entrepreneurs as to the process.

First off, let me state that VC money is a first step but it is never enough on its own. Judging from how most VCs and angels fund more losers than winners, there are plenty of examples that will attest to that.

Now if you want to go to the root of it I really believe it all depends on the type of business you are in.

1. In Consumer Internet entities, it lets you defer revenues, and thus maximize users and go for the viral effect. This for example worked quite well for Facebook, Google, Instagram, Twitter, Tumblr, etc…. Basically, if you can defer revenues and thereby become a Top 100-200 website, then the result is outstanding…. But if VC money can’t get you to be a Top 400 website — then forget about it altogether.

2. Not the same situation in Business Internet type entities where it lets you scale more quickly by creating, chasing and closing longer- and lower- ROI opportunities. The maxim in here is that you should try to recover your sales & marketing expenses on a customer by Year 1. So it’s a good model but only works if you have capital to fuel the engine. Otherwise, once you add in all the other costs, you’ll be bankrupt. Hence, if you have significant sales and marketing expense, you’ll likely be significantly handicapped in how quickly you can expand and grow without capital. So in Business Internet, if VC money can’t meaningfully accelerate your growth to a high level, and you can’t see a way for that growth to compound, you should pass on VC money as well.

Bottom Line: These are the cases where VC money can indeed become a curse.

Look at it this way… If you take capital to begin that business, your investor is now going to have a say in every major decision you make regarding the business. Now let’s say that someone wants to acquire your business for $5 million – you’d make a nice profit if you had not taken professional funding. However, your investor is likely going to want to make more of a return on their investment (or they’ll end up taking much of that $5 million buyout based on their investment).

However, if taking the capital is the only thing that will move your business forward or if it will shorten the amount of time from now to reaching your goals, it may definitely be worth it. It’s very much an individual decision based on your own goals.

Bottom Line: Venture capital by definition is funding used to help the business grow and develop, but of course there are never any guarantees.

More money usually increases the chances of success but there are thousands of other factors like poor management, no market fit, better competitors, etc…. that can cause your startup to fail, regardless of the money it has. Overall it’s a blessing but it really comes down to how effectively the money is used, not how much you can get, that determines your success.

With less capital it’s harder to scale — and that’s actually a good thing. Scaling too soon forces you to grow and make decisions before your company is ready. Expectations are lower with less capital. And your milestones will be more manageable.

Also, larger amounts of capital lead to unnecessary dilution at a lower valuation. Conversely, smaller amounts of capital allow you to preserve more ownership — and can lead to higher valuation in future rounds.

The sooner you sell equity, the more it will cost you in the long run in loss of leverage as well as dilution. Instead I always advise startups to do everything they can to get their company off the ground and build traction prior to raising funds.

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