Just Say No to Venture Capital

There is a constant stream of entrepreneurs that ask me to invest in their idea or ask me advice about how to raise venture capital for their business plan.  In many cases, they should just say no to venture capital.

There are a lot of benefits to raising venture capital such as the ability to fund a big capital need in a company’s early stages, the ability to tap into the investor’s savvy business advice and mentoring, and the ability to tap into the investor’s deep relationship network.

But there are also a lot of disadvantages to raising venture capital such as spending a lot of time trying to raise the capital, the very low probability of ever getting any, the loss of ownership, the loss of control, and the yoking with investors that may not share your values.  In short, venture capital is a lot like debt bondage.

Many entrepreneurs are uninformed about Venture Capital and don’t realize all the negatives. They usually don’t realize

  1. How hard it is to qualify for venture capital (it’s been reported that only 1 in 4,000 that seek venture capital ever get it). There is almost an attitude from many aspiring entrepreneurs of “just give me some money and don’t ask me any hard questions and don’t make any demands.” I had one entrepreneur demand that I immediately invest in his business during the second conversation! Just that very attitude knocked him out of any consideration.
  2. How long the process takes (6 – 12 months or more), of which 2 – 3 months is probably spent just to get your business plan materials ready to be presented to instutional investors. The ongoing due diligence is grueling and can derail a young company because of the time and energy it takes.
  3. How much business owners give up in the process. Entrepreneurs are often shocked when I tell them how much control is lost (usually 100%) and how much ownership is lost (in many cases up to 90%) in the process.

Why is raising venture capital so difficult that only 1 in 4,000 that attempt to raise capital ever get it? Here are three key reasons:

  1. Your deal has to be a perfect fit with the venture investor in terms of their geographic focus, their industry focus, their deal size, their deal type, their investment stage, their syndication preferences, their fund timing, and their view of your fit with their current portfolio.
  2. You need to convince the investors that your company/deal is the best investment opportunity of all of the deals they are currently considering (and they will consider hundreds of business plans in any one year).
  3. You need to convince the investors that you are the best entrepreneur of all of the entrepreneurs they are currently considering (again, they are seeing hundreds of entrepreneurs in any one year, many of them with very successful track records of previous wins).

One good reason to just say no to venture capital is that it forces you to be creative. Thinking that you can simply raise millions of dollars without hardly any downside to launch your business is a bit of a lazy approach to entrepreneurship.

So what is a creative way of bootstrapping your startup and getting the resources you need? When I was living in Minnesota a gentleman approached me to inquire about raising capital. He had a fabulous coating that he had developed over a period of years in his basement that when applied to a window, nearly doubled the R-value or the insulation properties of the window. Because I lived in a place that required you to nearly burn money to stay warm because the heat seemed to fly out the windows, I was immediately interested in his product.

His response to my first question about how many customers he had was something along the lines of “I’ve been too busy developing and perfecting my product to sell it just yet.” His response to my next two questions about how much money he thought he needed and what he needed it for was telling when he responded that he needed several million dollars to build a plant to produce the product and hire a sales and marketing team to sell the product. That’s all I needed to hear.  His likelihood of ever raising any capital from anyone including me was zero.

My turn down was gentle and I hope my advice was helpful.  It went something like this:

  • On the sales side:
    • The best target customers for your product are likely to be windows manufacturers that would love to have a value-added coating that doubled the R-values
    • Windows manufacturers already have well-established distribution and sales channels throughout the U.S. that took to hundreds of millions of dollars and decades to build
    • The two largest windows manufacturers in the U.S. are right here in Minnesota
  • On the production side:
    • The best way to get your product to market is to contract with a polymers and coatings manufacturer to produce it for you, rather than to build the production capability yourself
    • Two of the largest polymers and coatings manufacturers in the U.S. are right here in Minneapolis/St. Paul

My advice on his immediate next steps was to get his invention protected and then to meet with both of the windows manufacturers. The best guys for him to get in touch with would be the new business development group. It would be helpful if they knew that he was talking to the other guys because they were very competitive and would want the edge. That kind of positioning usually gets fast attention and a quick deal. If he struck gold with them, then all he had to do is go across town and negotiate a deal to have enough of his coating formulated and produced for a market test.

My parting shot to him was “you don’t need venture capital, you just need to make two sales calls.”

Now I know that setting up meetings and selling it is not the easiest thing for a scientist/inventor like him to do, but raising venture capital and expecting someone else to put the company together was avoiding the necessary work. It also would have meant that he would have given up most of the value of what he had created and that would have been the biggest shame of all.

The other point to drive home is not to waste any money building infrastructure that already exists. For him to hire and build a sales and marketing network to sell a single product made no sense at all. And, for him to build a factory to produce a lone product that no one had ever purchased or even heard about was equally as foolish.

For him, the real value should have been to own the idea and partner with others to take it to market.

As I escorted him to the door I encouraged him by telling him that he was only two meetings and two weeks away from knowing whether or not he had a hit on his hands.

Document Downloads:

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Training:

  • Venture Academy (especially the Finance and Accounting section and the Legal section with a special focus on the Harvard case study on a licensing arrangement)

About Wade Myers

Wade has founded or co-founded, invested in, and been a director of over 25 companies and has completed 55 financing and M&A transactions. His previous work experience includes the Boston Consulting Group and Mobil Corporation. Wade also served as an Airborne Ranger in the US Army where he was a decorated veteran of the Gulf War. He is a Baker Scholar graduate of Harvard’s MBA program and is married with five children.

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