Every week my team and I review a lot of startups. We greatly appreciate seeing all of these opportunities and have immense respect for founders who put themselves out there to pursue their passion. Generally speaking, raising money for your business is standard practice, but I want to help founders understand the pros and cons of raising capital from venture capitalists. I also want to share my thoughts on what types of companies are a better fit for VC funding.
As a seed-stage venture capital firm, the majority of companies we see are early in their development progress. Every so often I meet founders who have made considerable progress without any outside capital. In even rarer cases, some founders have done incredibly well from the outset with zero marketing spend, very low burn rates, and positive unit economics. We don't see this often but when we do it stands out.
We recently had a founder reach out to us who had the following metrics: $0 spent on marketing, $0 outside capital raised, and $8.5 million in LOIs from a product built in less than 2 months. I met another founder who was cash flow positive with $6000 in monthly recurring revenue (and growing) and they'd only raised $100K from an accelerator program. Both of these companies had clear product market fit and were crushing it. In these types of cases, I often ask myself "why do founders in this situation feel like they need to raise venture capital if they absolutely do not have to?"
In the very early days of starting a company, I don't think there's anything wrong with postponing fundraising. First, not raising outside capital allows you to focus all your efforts on growing your company and you can avoid the distraction of fundraising. Second, you can hold on to more equity in your company longer. Finally, if your company continues to excel you can command a higher valuation once you decide to take on outside investors.
There are of course downsides to not having outside capital especially if your company is performing well. First, you'll have to rely on company profits or your own balance sheet to grow. Taking on debt can be a solution. However, to obtain this type of financing you need to have an operating history that proves you can pay the loan back. Second, the tradeoff for relying on your own financial resources can sometimes result in slower company growth. Third, slower growth could result in losing market share to competitors. I like to say that there are good and bad problems. If you're dealing with the challenges of rapid growth without raising capital, these are worthwhile problems that are easier to figure out than the alternative.
There are some business models not suitable for venture capital. For example, service-oriented businesses with little technology integration such as maid services, construction contracting, consulting, sales, lawn care, car services, and technical trades (plumbing, electrical, HVAC, etc.), or any other businesses that heavily rely on service without a repeatable income stream. These businesses are not highly scalable as each unit of output is contingent on an equal unit of input. Technology companies on the other hand are able to produce exponential units of output from relatively small or minimal levels of input. Hence, they are more scalable than service-based businesses.
I also think we're living in an era where many founders are (way) too comfortable during the company building process. A question I like to ask founders is "what have you sacrificed personally, professionally, or financially to get to this point in your business?" I very rarely hear stories of founders who've resorted to sleeping on their friend’s couch, building their company in their parents garage, or eating ramen for six months to get their companies off the ground. I think if more founders had this mindset they could do more with less money and might be less concerned with raising outside capital.
According to Pitchbook Q3 2024 Venture Monitor Report, 57,574 companies in America have been unable or unwilling to exit. As a comparison, this number was 46,139 three years ago - 25% lower. This has become a two-sided problem. First, investors seeking or needing liquidity are frustrated by the lack of exits. Second, founders raising capital are unable to do so, resulting in an overwhelming backlog of companies.
I'm a strong proponent of entrepreneurship and continuous innovation - it's part of our DNA as Americans. However, I think there are a lot of founders who should ask themselves what it is they really want and not feel like they're not succeeding if their companies don't reach unicorn status. As VCs, we need to back companies with enormous growth potential because the outsized returns from these companies make up for the others we back that don't reach this level of success (or outright fail). I know a lot of entrepreneurs who've started, grown, and sold highly successful businesses that will never make front page news. Most of them raised very little to no outside capital.
At the end of the day, if your real goal is to be financially independent and provide a comfortable lifestyle for yourself and your family, raising venture capital and building a billion-dollar business isn't the only way to do that.
Cheers - KM
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