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From a founder’s perspective, there are two main considerations when thinking about whether venture capital is the right form of fundraising for their business: money and time. Venture capital can be a good option if your company needs a lot of money up front before it can bring in revenue—that is, if it’s capital intensive—and if the company needs to grow rapidly to beat other companies to market.
Capital intensive businesses often involve a J-curve, where the business needs to invest a lot of money in research and development before it can turn a profit. Today, biotechnology companies are still highly capital-intensive, as the period needed for experimentation and clinical trials—all before any revenue—can be years or decades. Software companies, on the other hand, generally require less capital than they used to—today, they can turn to cloud-based providers like Amazon Web Services and Google Cloud Platform instead of spending millions on their own servers.
But that isn’t to say software companies can’t be capital intensive. In some cases, companies need to lure particularly specialized—and therefore expensive—employees. Self-driving car startups, for example, need to hire PhDs and also need to purchase expensive hardware before they can even begin much experimentation at all. In other cases, a team will be close to finding a solution for a market, but they need time to iterate, test, and repeat cycles of exploration before finding something that works. If your company faces any of these challenges, raising venture capital may be the right fit.
Companies often raise venture capital to finance growth once a company has found a business model that works. The idea here is that once you’ve figured out how to sell a product successfully and repeatedly, you may want to go hire a larger team to improve and sell your product to the market before someone else beats you to the punch.
controversy Taking venture capital almost guarantees that you will be pushed to grow as fast as possible. You may not agree with the strategy or tactics suggested; some founders have opted to bend or even break the laws to achieve this growth, and many founders and venture capitalists ignore rational economics (such as making sure you aren’t spending more money on acquiring a customer than you make in revenue from that customer), hoping it will all magically work out in the end. Here are a few examples of challenges related to growth in VC-backed companies:
In 2014, investors in HR startup Zenefits called then-CEO Parker Conrad’s $10M revenue goal “bush league.”* Subsequently, the company went on to face multiple scandals, including a founder-sponsored program training employees how to cheat on state licensing tests, that ultimately resulted in Conrad’s departure.* Despite this, Conrad has since gone on to raise $52M for another HR-related startup, Rippling.*
In 2016, e-commerce startup Nasty Gal filed for bankruptcy after bringing in nearly $100M in revenue at its peak. Much of Nasty Gal’s growth resulted from spending on advertising, which ended up being unsustainable.*
The most egregious case of misconduct in the last ten years came down to a case of flat-out fraud at Theranos. Now the subject of a book, Bad Blood, and an HBO documentary, The Inventor: Out for Blood in Silicon Valley, the fraud of Theranos was perpetuated in part because of investors’ (and media) focus on the scale of the company’s impact and market deterred the due diligence that could have revealed the fraud. In this case, the prospect of disruption and returns outweighed the discipline to make sure the innovation was real.
What Does Success Mean to You?
Venture capitalists are motivated—at least in part—by the prospect of huge returns on investments that will make them and their investors rich.
The fact that VCs need to return large sums of capital to their investors creates some incentives that may not align with a founder’s goals. To meet their investors’ expectations, venture capitalists seek to invest in companies they believe can be the biggest, most successful companies in their market.
Some firms out there are happy with smaller returns and smaller exits, and some investors work closely with founders to make sure no decisions are made that the founders are not comfortable with. Other investors are motivated by, in addition to high returns and big exits, the impact their portfolio companies might have on the world. (You’ll learn how to research and discover firms aligned with your interests in Creating a Target List of Investors.) But the VC business model is predicated on growth—there are countless stories out there about companies that were pushed by their investors to move too fast toward becoming a $1B+ outlier. What’s the downside of that?
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