Not Every Startup Should Be Venture Backed

A quick gut check

In this record fundraising year, (and despite the recent hiccups, record year in the public markets) we are beginning to see a lot of companies raise institutional venture capital simply because it’s widely available and the Silicon Valley bull market default. Many people feel they have to take venture capital, or they get pushed into it by investors looking for opportunities. This is bad.

Out of the approximately half million businesses with employees that get started every year, only about a thousand are venture-backed. However, in the current environment we are conflating “technology startup” with “venture-backable.”

Hanging out yesterday, a friend (in a leadership role at a startup) mentioned his Xoogler friends were hacking on something, and were probably going to raise money when they shouldn’t.

He suggested there ought to be a checklist — should you raise institutional, Silicon Valley venture capital or not?

Here’s a quick crack at that:

  • Can you do it without venture money? If so, and you’d be happy with the trajectory that option offers you, why raise money?
  • Are you willing to trade ownership in your company (and some control) for a partner in your corner who will hold you accountable for their capital? Do you like and trust that partner and their organization?
  • Are you personally ambitious to build a huge commercial business that will have impact on many people? Is that a driving priority for you? To define “huge,” are there acquisition or IPO outcomes for that business that will drive a multiple on investment that will excite your VC backer? Do you understand how companies like yours are valued? The very top tier VC’s are trying to a magnitude multiple on their early stage investments. We need to have ambitions aligned with the teams we back. The more money you raise, the higher you set the bar.
  • Are you focused on getting big, fast? How much capex will it take to get you from here to there? VC funds have 10 year horizons, and even the biggest platforms are investing a limited pool of capital across a portfolio of risk. Some funds can and do hold positions for longer than that, but as a rule of thumb, you should see a path to an exit or independence within that horizon. Your planned path also needs to have milestones of progress and de-risking that enable you to raise intermediate rounds of institutional capital.

Elon Musk put $100M of his own money into SpaceX before he raised $20M in “Series A” VC money from some of his former Paypal cofounders in 2008 (6 years of work and 3 progressively closer-to-successful launches into the company’s life). It wasn’t until 2009 that they received their first (relatively small) commercial contract. Even if a fund is of the billion-dollar scale, investing $120M in a single company to fund development over 7 years before basic technological and commercial de-risking is untenable in an area with weak intermediate outcomes. Who would buy SpaceX if it didn’t work?. However, if some of that risk is taken off the table, as it had been here by 2008, the investment and risk profile changes dramatically — and that investment looks like it will do enormously well for Founders Fund.

Enterprise software and consumer internet investments have been the focus of many venture firms for a long time because of their potential to reach scale quickly with high capital efficiency. Certain dynamics are arguably making investments in other areas increasingly viable (for example, cheaper/faster to produce consumer hardware/electronics), but the expectations haven’t changed.

VC’s (including myself) are often somewhat disappointed when they find out their smart, driven, dynamic friends are working on businesses that shouldn’t be venture backed. There are only so many talented people in the world. :( However, if that’s you, be flattered by that dynamic, answer these questions honestly for yourself, and don’t raise money just because it’s the default. Raise to empower and accelerate your mission.

Two quick stories to illustrate:

About a month ago, I was looking at investing in a young team who had built a beautiful, forward looking data product with some interesting technology and potentially wide applicability. I think there was opportunity to build a huge commercial business that has impact on many people. The team had raised (traditional, valley-style) seed capital. In parallel with their Series A fundraising process, 18 months into the life of the company, a tech giant made them an acquisition offer. We offered them terms, and they sold the company anyway. The founders got serious cash — at an acquisition price that doesn’t move the needle at all for Greylock, but is life changing for them. And that’s good. If I convince you not to sell your company but you don’t independently want to build the business, we’re out of alignment. Maybe that’s your first golden ticket, and in 2–4 years, we’ll work on your next company together.

I met some talented technologists yesterday. They quit their jobs, they hired a few other people, they hacked together a cool product, they’re working on some contracts. Their technology is almost fully open source. They told me, we’re not necessarily interested in building this into a big business, we just want to hack on the technology. We raised some money from friends and family, we can get paid enough to do this as a lifestyle business and we don’t want the pressure of institutional investors to grow this or to figure out a commercial model. And that’s good. If I convince you to take money and you don’t independently want to build the business, we’re out of alignment.

These kinds of stories will keep happening. But these stories are much better outcomes for everyone than finding out somewhere down the line that you and your backers are out of whack on what scale of organization you’re trying to build. Bringing a good venture partner on board means you’ll get someone who will support you, who will share your long term ambition, but will also push you to build both fast and big, and hold you regularly accountable to visible progress on that front. It’s a long term decision that will outlast the current euphoria in the fundraising markets.

As long as you want that, and you do have that aligned ambition — it’s on!

Published in Startups, Wanderlust, Life Hacking | Medium’s Top Publication