Should you be looking to raise institutional (VC/PE) capital?

My work over the past 7 years has largely revolved around helping companies raise capital and building technology to help them do so, around the world.

I have worked on mid market equity and M&A through my founding of BankerBay and have worked with thousands of early stage startups through my founding of Marquee Equity.

As a result, I speak to perhaps over 1,000 new companies each year about their fund raising plans.

Being a startup ourselves, we’ve grown over the years and I’m unable to speak to each company that comes through our door, personally, any longer (detaching me from the part I used to love most about my job!)

Which is why I’m penning some of my thoughts and learnings in the hope that they can at least help the entrepreneurs we’re working with get a good sense of how the fund raising ecosystem works and whether or not its suitable to their particular use cases.

This first piece specifically focuses on whether one should be looking to raise outside capital!

So, should you be raising capital in the first place?

One of the first things I brainstorm about, while discussing companies’ plans to raise, is whether they actually do need to raise or are even VC/PE Compatible.

One has to appreciate, there is in most cases, a gap between what founders believe to be a great outcome and what VCs would accept as a great outcome.

A $500,000 a year dividend line for the next 10 years or a $20M exit are very good outcomes for founders but are near failures from a VC standpoint.

To know why, lets begin at the beginning.

Where do VCs get their money from and what do they want to do with it?

VCs raise capital from Limited Partners (family offices, banks, pension funds, endowments, insurance companies et al).

These Limited Partners are large scale money managers and typically deploy capital into safe investments (stocks, real estate..) and accept 7–8% annualised returns as great outcomes. Their business is more of stable capital preservation than of high growth capital appreciation.

VC investment strategy is a lot more high risk and therefore to attract capital from these low risk investors, VCs must promise higher returns.

Delivering 3–4x the fund size is the promise..

For a closer read into how VC Fund math works, do read this excellent post by Tomer Dean, Founder of Bllush and this post from Fred Wilson of Union Square Ventures

The fact is, VCs look for companies that can generate huge returns quickly and for that they look for companies that operate in large enough markets ($1B+ in Total Addressable Market) and growth trajectories steep enough to be able to achieve $100M in revenues within 5–7 years, for them to be able to generate a “unicorn exit”.

Are you building something that can sell/IPO for $500M-1 Billion — QUICK?

Because that’s what it takes for 2 things to happen:

1. The VC to generate a return
2. For you as the entrepreneur (and a common stock holder) to generate significant liquidity for yourself and your team — because given that quick outcomes take multiple funding rounds and each funding round comes with a “liquidation preference” — you’re not actually generating a return for yourself and your team unless you deliver a huge return, quick

What are liquidation preferences?

For an in depth look into liquidation preferences, do read this insightful post from Charles Yu.

When raising capital, the term sheet you receive from investors will typically contain a 2–3x liquidation multiple.

What this means is, lets say you have raised $10M from VCs, on a multiple of 3x, the first $30M that is generated from the exit, will go to the VCs.

Which brings us to….

Selling for 100s of Millions and not making any money?

Yes, this happens a lot (lesser so in the hundreds of millions and often in the tens of millions exits) and mostly on account of liquidation preferences.

Have a look at the Fanduel story, where the founders, over 9–10 years, built a company that raised about ~$400M in funding over multiple rounds, had ~$125M in revenues, that was valued at over $1 Billion in its last funding round and that sold for $465M — and where the founders and initial team didn’t make any money on the exit.

Why?

Liquidation preferences.

There are hundreds of other unreported examples where a company raises multiple millions, gains traction and is sold for tens of millions of dollars and where the founders and early team make very little to no money.

You will spend the next 5–10 years building your company. That’s a good percentage of your life.

The Fanduel example is something you have to bear in mind while considering raising capital.

Does VC fit into your life?

Exits, multiples and numbers aside — for a lot of us entrepreneurs, our businesses are our lives and our lives are our businesses.

We start out because we don’t work well in silos. We’re freedom loving generalists who fight fires and solve problems, day in day out.

One has to truly ask oneself — would I prefer to strive and fight, and at the end of it, build something that pays me anything north of $1M a year (excellent money in most places, including Silicon Valley) or would I put in the same strive and fight to play the odds (the odds of raising money are low, successfully scaling post raising are lower and being able to be in a situation where you generate a big enough exit for yourself and your investors are in the 0.1% territory).

Whether you bootstrap or raise capital, you will take on the same amount of work, stress, anxiety and financial pressure. Beyond this active effort, you will think about your company 24/7 — all the time. You will have dreams and nightmares about it.

What would you do it for? What would you undertake the anxiety, stress, financial pressure, uncertainty and everything else that comes with it for — that’s the question one must answer to oneself.

What odds would you be willing to play?

If you’re a go big or go home type of person and you’ve started a business than can indeed attract outside capital and that you’d be willing to “almost gamble” the next 5–10 years on, outside capital is for you.

If not, customer sourced capital is king and there are vast profits to be made levering the internet, new technologies and the power of mass global distribution in today’s world.

This initial choice will determine the outcomes of the next few years for you. Think well!

Here is Emeric Ernoult, Founder of Agorapulse, a bootstrapped and profitable SaaS company, with his thoughts on why not to raise venture capital

Happy to talk 🙂

You can find me on [email protected] and I’d love to get on a call to discuss your fund raising plans and how I could be of help.

I’d be happy to talk even if you’re not raising capital and would just like to speak to a fellow entrepreneur and exchange war stories 

All the very best to you. 🙂

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