Don’t raise venture capital

I bet your startup should NOT raise venture capital. In fact, I think there is a good chance that venture capital could ruin your technology business. It’s true that some businesses need to raise substantial amounts of funding to create value. However, many of the companies that I talk to, especially in the Web 2.0 space, do not need venture funding and probably should not attempt to raise funding from VCs.

Let me provide a little bit of context here, so that hopefully you can understand where I am coming from (and hopefully so that you don’t think I’m a cocky jerk.) Yesterday I attended a roundtable Web 2.0 session sponsored by TCN over at Babson College. It was a good event that was quite well attended. I met a number of smart people who were starting internet businesses. (Also, please note that in this post I’m talking about internet businesses – some other industries such as semiconductors or clean technology have clear up front capital needs and most likely have to raise venture funding.)

During a panel discussion, a well known and quite successful venture capitalist was answering questions from the audience. As this VC was speaking, I could see the entrepreneurs in the audience becoming depressed as the VC made it clear how hard it was for the typical Web 2.0 company to create venture returns, and thus how difficult it would for the startups in the audience to raise venture funding. 

I had the chance to make a comment during this panel and my point was simple: there are a lot of potentially quite good small businesses in this room. A number of the CEOs I spoke with had ideas that could potentially generate $100k to $200+k a year in income. These would be great companies to own, and I encouraged people to pursue these ideas. However, they would be horrible venture capital investments. Good VCs (and by good I mean big, which may or may not be the same thing…) need to generate hundreds of millions in returns just to break even on their funds.

A venture capitalist will push their portfolio companies to go for broke every time, even if it is highly risky. If a VC had a choice between forcing a company to shoot for $100+ million in revenues with a 5% chance of success or going for a guaranteed/low risk $10 million in revenue the VC would choose the 5% chance. This is because the VC doesn’t return real capital to the fund with the $10 million company – despite the fact that for most entrepreneurs owning a company with $10 million in revenues would be quite an accomplishment.

Internet companies these days are in a pretty sweet spot. Many internet businesses can be launched with minimal capital outlays by leveraging open source software and cloud computing platforms. If you can get a startup going with a couple of hundred thousand dollars then you probably don’t need venture capital, at least initially. The only time that you should consider venture capital is if you really want to create a business with $50 – $100 million plus in revenue. Even then, I’ve seen quite a few businesses that appear to be on that track without having raised venture funding. Of course, those companies are in the funny spot of being called on by venture capitalists (which probably merits a post of its own someday…)

My key point is pretty simple. You likely do not need VC funding if you are playing in the Web 2.0 space. Launch the company, raise a bit of friends and family money and maybe some angel financing. Only if you’ve got a ridicoulously huge idea should you waste your time with VCs.

Author: Healy Jones

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8 Comments

  1. *Sigh* If only the bootstrapping option weren’t so damn hard. Quitting your day job is quite a bit easier when you’ve got a war chest of VC funding that will carry you through for a year or two.

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  2. To Micah’s point, you can easily raise a couple hundred K of angel money and pay yourself a small salary. That helps quit the day job, will keep you going for a while, and will still enable you to give it a good go. Of course, it means you’re still bootstrapping, but that is the way to go. It’s never been easier or cheaper to start a web based business!

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  3. Don’t a lot of angel investors expect you to seek VC money further down the road? and are hoping for acquisition eventually.

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  4. Discounting venture capital as an option forces entrepreneurs to generate real revenue now. It forces them to have a functioning business model; to be a “real business” -which is actually quite rare in the Web 2.0 space. I think that in general, this is a more healthier approach.

    I’m interested in your example though, of a company with 100 million in revenue, as this is theoretically a billion dollar company at 20x earnings (if half of that income is net). Surely a VC can deliver what others would consider “successful” returns to the fund without a company getting that big? Take the company with 10 million in revenue, and let’s assume again that half of that income is net (which may be a ludicrous assumption -I’m not sure). That’s a 100 million dollar company at 20x earnings. So that’s not going to deliver VC returns, but surely a company with 40 million in revenue can make an exit that would be respectable? I mean Digg just tried to sell for 200m and they’re backed by Greylock among others. Would this have been considered an unsuccessful exit if the sale to Google went through?

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