Your business needs outside capital to grow. But, before you start building investor lists, take the time to determine if venture capital is the best fit for your growth plans. Remember, venture capital is one of many possible routes you can take to propel your idea to the next level. We’re giving you the breakdown to determine if VC is right for you.
To understand why you need to have a billion dollar idea to qualify for venture capital you have to understand the game that VCs are playing. Your investors have investors. You heard that right. Venture capitalists, or general partners, raise money from limited partners to establish their fund. The goal of the fund is to return 10-30x the initial investment back to LPs in 10 years.
Venture capital funds follow a power law curve. This means that the majority of returns come from a few (or even one) investment in their portfolio. Why are we boring you with laws? The power law is essential in determining your qualification for venture funding, because you have to be able to convince VCs that your business will be the one that returns for the entire fund.
Do the math, to determine if your business is venture backable
To return 10-30x for a venture capitalists fund, there are only two viable exit options for any venture backed company: go public, or get bought. Remember, you already agreed to build a billion dollar company by accepting VC money. To do that in 10 years, your company has to grow - a lot, and quickly. This emphasis on growth and high returns can have very real and negative side-effects for your startup:
i. It can dramatically increase burn rate early on
ii. There’s not time to fix small problems, which can turn into big problems
iv. Founders may be forced to pass on present exit opportunities for a more improbable future exit
When you raise venture capital, you are selling a portion of your company and taking on additional business partners. This loss of ownership and control is called dilution. It is one of the most important topics for any startup founder, and one of the most difficult to understand.
i. Here’s a helpful infographic to help visualize the impact of dilution.
The bet that you’re making by accepting venture capital, is that even though you own a smaller percentage of your company the value of the company has increased enough to make your stake personally more valuable. At the seed stage you should expect to sell between 10-20% of your company to investors. This percentage depends on how much you want to raise and the valuation of your company. The ideal is to raise as much money as possible to reach profitability, so you’ll never have to raise again. The more realistic result is that you’ll raise enough money to sustain operations for 18 months plus or minus 25%.
Before deciding if venture capital is right for you, understand how dilution for this and future rounds will impact your ownership. Founders, beware of unknowingly losing control of your company.
No doubt there’s a certain cache in raising VC money. However, because success for venture capitalists is returning 10-30x to their investors in 10 years, the future expectations of your company are set as soon as you accept their money. Before saying yes, have an honest and realistic conversation with yourself and your founding team on if this future is actually possible and what you really want. If the answer is yes, we can’t wait to help you get started.
At FundBoard, we’re on a mission to make every founder an insider. We match founders with the right investors at the right funds to invest in your idea. We add crucial hours back into your day and change the probability that your fundraise gets done.
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