Investors and founders reveal how to know if venture capital is the best way to fund your startup, and what paths to take if it clearly isn't

young professional millennial

  • Successful entrepreneurship
    is about knowing the best way to fund your business.
  • Raising venture capital isn’t always the
    answer.
  • VCs say the most important factor to consider is market
    size: How big could your company get?
  • Ultimately, VCs want a big return on their initial
    investment.

  • Click here for more BI Prime stories.

If you’re thinking about raising venture money for your startup,
you should start by asking yourself one question:

Is this business appropriate for a venture capitalist’s
investment?

Too many founders answer “yes” (if they bother questioning the
wisdom of raising venture capital at all). It’s part of how
high-profile companies like Amazon and Google achieved success, the
thinking goes, so it must be advisable for every startup.

And yet, in blindly pursuing venture capital, these
entrepreneurs are setting themselves up for a series of rejections
(or a difficult partnership with an investor down the road).

That’s because VCs look first and foremost at a company’s
potential market size. If yours isn’t large enough, they won’t want
to work with you.

The economics have to make sense for a VC to invest in your company

David Rose, who
runs Gust, a digital platform for early-stage entrepreneurs and
investors,
previously told Business Insider
that a VC’s decision comes
down to numbers.

If, say, you’re bringing in a maximum of $1 million a year in
revenue, “it may be a great, wonderful, much-needed business,” Rose
said. “You may be doing the world a favor, or you may enjoy it and
support your family. You may be able to make a fortune yourself and
take vacations.”

But, Rose emphasized, the economics of a business that brings in
$1 million a year in revenue “are just such that there is no way
that you can get an investment from me at any reasonable number for
that to make economic sense.”

Rose’s approach to investing is hardly unique: Investors expect
outsize returns on their money. Sometimes it’s even a large
multiple of what they put in. If your startup is generating revenue
in the low millions, or if the likely exit price is in the low
millions, a VC has minimal incentive to support you.

That’s especially true because VCs are well aware that most of
the companies they back will fail. In fact, they generally make
money only from the sliver of portfolio companies that are wildly
successful.

Market size is the most important factor in a VC’s decision to
invest

Take it from Scott Kupor, managing partner at Andreessen Horowitz, the venture-capital
turned
financial-services firm
that invested in Facebook, Airbnb, and
Lyft. Kupor
previously told Business Insider
, “For a venture capitalist who
knows that they’re going to be wrong a lot of the time, they have
to figure out what’s the likelihood this company could be in that
upper-right tail of returns” (the small number of companies with
the highest return on investment).

Kupor went on: “When we’re doing an early-stage investment, what
we’re trying to imagine is the ‘What if?’ question. ‘What if this
company worked? What could it look like? How big could it be? How
much revenue could it generate? Ultimately what could the equity
value be?'” Then Kupor considers, “What do I think the likelihood
is of that happening,” based on what he knows about the
company?

Read more:
Founders and investors reveal the ultimate guide to scaling a
startup — and common pitfalls to avoid

For entrepreneurs, that translates to one all-important
consideration. In his 2019 book,
“Secrets of Sand Hill Road,”
 Kupor said anyone raising venture
capital should be able to convince themselves and their potential
investors that their business is able to bring in several hundred
million dollars a year in revenue over the next seven to 10
years.

That means you could reasonably take your company public at a
market capitalization of several billion dollars, Kupor writes.
Which in turn means that “the returns to the VC on this investment
should be meaningful enough to move the needle on the fund’s
overall economics.”

A business doesn’t have to be a unicorn to be successful

To reiterate what Rose said, if you aren’t positioned to become
the next Google or Facebook, that doesn’t necessarily mean you’re
not building a successful business. It means your company may be a
“lifestyle startup,” which doesn’t require venture capital and
probably won’t ever be a “unicorn” worth $1 billion.

Read more:
The founder of a billion-dollar startup says you need to nail
‘message-market fit’ if you want to raise millions from
investors

In the book, Kupor mentions smaller VC funds and debt financing
from banks as two potential paths to raising capital without
traditional VC money. (You can also
bootstrap your business
, using personal funds and money from
friends and family.)

Perhaps the most important takeaway here is to clarify your
personal definition of success. You don’t have to build a unicorn
to get there.

As Angela Lee, founder of the venture-capital firm 37Angels and chief innovation
officer at Columbia Business School,
previously told Business Insider
, a lifestyle startup can
easily bring in $10 million a year. And, Lee said, “since when did
making $10 million a year become a failure?”

SEE ALSO: How
to know it’s the right time to launch your business, according to a
former Amazon VP who just raised $4 million for her skin
tone-matching beauty startup


Join the conversation about this story »

NOW WATCH:
Kylie Jenner is the world’s second highest-paid celebrity. Here’s
how she makes and spends her $1 billion.

Source: FS – All – Economy – News
Investors and founders reveal how to know if venture capital is the best way to fund your startup, and what paths to take if it clearly isn't