Venture is not the only option

Venture Capital is glamorized and celebrated as the best route for every company, but it isn’t the right funding option for many businesses. It should be no less aspirational or exciting to self-fund businesses, take on debt, or grow non-profits.

Fantastic businesses have been built and scaled without venture capital, for example:

• Mailchimp which bootstrapped (or self-funded) their growth, or Skyscanner, which ran for six years before raising Venture Capital.
• Khan Academy, the education technology company providing educational tools and resources to millions of children, which is a non-profit.
• Cards Against Humanity which raised their initial $15k of funding through Kickstarter and built the company from there.

It is frustrating that raising Venture Capital funding is seen as an important milestone or the mark of a ‘good’ business. It is a tool like any other and it should be presented as such, with the pros and cons clearly signposted. It’s also troubling that many funding options aren’t available to all founders, for example, the idea of ‘friends and family money’ which is completely unrealistic for many people.

At Ada Ventures we believe that we need to do more as an industry to be transparent about when venture capital is not right for a business.

As Josh Koppleman puts it:

“Big problems have occurred when you have founders who have unwillingly or unknowingly signed on for an outcome they didn’t know they were signing on for […] I sell jet fuel […] and some people don’t want to build a jet.” — Josh Koppleman, investor at First Round Capital as quoted by Erin Griffiths in the New York Times.

This guide should be read before starting your company and should help think through:

• The right company structure
• The right funding route
• Some questions to answer before deciding to take venture capital

Space X’s Falcon Heavy lifting off. VC investment is like rocket fuel but isn’t right for every business.

Decide on the right company structure

Before starting a company and way before considering venture capital funding, think about what the right company structure is for you and your definition of success. What is the principal mission of what you’re building? Are you interested in maximising value for shareholders, which is the primary purpose of a company? Or are you interested in having maximum impact on the biggest possible number of people, which might be a better fit for a non-profit? Are you trying to change policy? Or create a product that will be bought by millions of people? This will help determine what company structure is best for you.

For-profit

• Limited company
• Limited company with B-Corp status
• Limited Liability Partnership (LLP)
• Social Enterprise (you operate as a company (not a charity), but you focus on maximizing social impact as well as financial profits)
• Community Interest Company (CIC)
• Company limited by guarantee (eg. Diversity VC) — enables you to set up subsidiaries which might make a profit in the future

Charity

• Entity with protected tax status, restricted from making or distributing profits. The core purpose is likely to be to help and raise money for others

When you have decided on the right company structure for you, consider the options available to you for funding your company.

Decide on the right type of funding for your business

Every funding option has advantages and disadvantages, and some are better suited to certain types of businesses and business models. It is important to explore the funding options available before deciding how to build your company as the route you take will have knock-on consequences.

The founder of RXBar, which was funded with $10,000 of the founder's savings and sold to Kellogs for $600m.

Bootstrap

Bootstrapping is a term for growing without taking on external capital. Founders can self-fund through selling products or services to customers which they can then use the proceeds to fund the development costs of their tech and team. This requires a highly disciplined approach to cash-flow management.

Best for

• Businesses that generate very early cashflow without much tech infrastructure (agencies, recruitment, consultancy).

Advantages

• Owning 100% of your company.

Disadvantages

• Difficult to start a company without savings.
• Slow growth.

Bootstrap + Debt

As above but consider taking on debt to finance growth, which could be done through invoice discounting, venture debt, loans. However debt is not widely available until your company has something to borrow against — (usually tangible) assets, or (predictable) cash flows — typically receivables or profits! Grants are also possible for businesses. Check out Innovate UK to see if you’re eligible for R&D grants which could bridge you to the metrics you need to take on debt (predictable cashflow).

Best for

• Businesses that generate very early cashflow without much tech infrastructure (agencies, recruitment, consultancy) but still want to grow and can raise debt.

Advantages

• Owning 100% of your company but also having the additional working capital to invest in growth.

Disadvantages

• You have to achieve a certain size or maturity to take on debt

Revenue Share

Taking investment, but instead of taking equity, the investor is paid back by a revenue share agreement. This is often capped at 3–5x the initial investment, and only kicks in after 1–2 years of putting the capital to use. Models can include a conversion mechanism into actual equity, if down the line that becomes an appropriate model. Model made famous by Bryce Roberts at Indie.vc but is not yet mainstream in the UK or Europe (AFAIK — please let me know if I’m missing a fund that does this)!

Best for

• Owning 100% of your company but also having the additional working capital to invest in growth, without the risks associated with taking on debt.

Advantages

• Owning 100% of your company
• Having access to working capital to grow
• Maintains the option for VC-like funding if that later becomes more appropriate.

Disadvantages

• Limited universe of investors.
• Typically requires higher margins to ensure the paybacks are palatable.

Angel investment

Early-stage investors who typically invest anything from £10k-£1m. Raising money from angel investors is quite different from raising money from venture capitalists. Some companies raise angel money first before raising VC, some companies find that angel investors are a better fit for them overall than venture capitalists. An overview of how to find angels is here.

Best for

• A light touch personal relationship and operational value add.

Advantages

• Not being encouraged to grow at the expense of everything else.
• You know what you are getting in terms of a board member (they are unlikely to leave / swap board seats with someone else).
• Can be faster to close on investors investing their own money, compared with a fund with longer processes

Disadvantages

• Very dependent on the kind of angel you have
• Can require a lead investor to close larger angel rounds

Crowdfunding

Crowdfunding sites allow you to aggregate many small ‘retail’ investors together. Typically they require you to create a video pitch and be prepared to answer questions from investors while you’re the business is ‘live’. Check out Crowdcube, Seeders and Syndicate Room which are the three major UK sites.

Best for

• Consumer businesses which can be easily understood that want to give their customers access to their company as an investment opportunity.

Advantages

• Can generate good marketing as well as investment.
• It is the most democratic form of investment as people can invest as little as £10.

Disadvantages

• Works best when companies have raised 50–75% of the round off the platform and they are using crowdfunding to finish off the round.
• Doesn’t work so well for B2B or complex businesses.

Accelerators

Accelerators or incubators fund companies that are pre-product. Typically the deal is a home for [two months], combined with mentorship and guidance, wrapped up in a demo day event at the end; in return for which you’ll give away 5% or more, which may or may not be paid-for equity (i.e. come with cash).

Best for

• Real hands-on, operational advice on building a product and in some cases, building a team.

Advantages

• Safe space to figure out if you want to do an idea
• Some great accelerators are equity-free and still provide real benefits and a badge of approval — e.g. FirstGrowth in the US.

Disadvantages

• Can be expensive in terms of equity % and there are widely varying levels of value add.
• There are purported to be over 500 accelerators/ incubators in the UK alone — be sure to reference past cohort companies to determine if the value offered is worth it.

Venture Capital

Venture Capital is typically for businesses after they have built a product and usually once they have some early customer traction. Venture Capital is usually equity investment of anything from £100k to £100m, for between 10–30% of a business, but typically 15–25% at each round, with rounds increasing in size as the businesses get more mature. Venture capitalists will invest in ~30 companies per fund, on the expectation that 1/3rd will fail, 1/3rd will do ok and 1/3 will hit a ‘home run’ (sell or IPO for at least 5–10x their original investment). Venture Capital is glamorized in TechCrunch and other tech media, but has real disadvantages for businesses that are worth knowing about before making a decision to take on this type of funding.

Best for

• Businesses that can grow and scale very fast.
• Businesses addressing a large problem, or a niche problem adjacent to a large market.
• High margin businesses (eg software), or where there are network effects as they scale (i.e acquisition of new customers gets easier as the company grows and the COGS are non-linear to each incremental user).
• Businesses with ‘winner take all’ dynamics like some marketplaces where rapid scale is crucial to success.

Advantages

• Capital comes with operational support and a strong network (depending on the fund that you work for).
• You will be part of a ‘portfolio’ of other companies you can learn from.

Disadvantages

• Can be expensive in terms of equity % and not all VCs provide value beyond capital. Reference them before you take the money.
• Once you’ve taken venture capital it is difficult to ‘go back’ to a bootstrapped business and you might need to continually raise money
• It is difficult to buy-out your VC investors, in fact, the average founder / VC relationship lasts longer than the typical marriage.
• You will be pushed to scale and ultimately exit the business at some stage so that VCs can return capital to their investors.

Questions to ask yourself before raising venture capital money:

(These are non-judgemental questions, but are a guide to how VCs may assess your business)

1. Is there a realistic possibility that you could sell your company, or take it public through IPO for at least £100m; and for bigger funds £1bn?
2. Are you building a business in a big enough or high growth enough market to do that?
3. Are you aiming to grow 2–3x y-o-y? Is your business model capable of potentially delivering this?
4. Are you open to putting in place a formal board?
5. Are you prepared to report to your investors on a monthly basis and hold board meetings monthly or every other month?
6. Are you prepared to have a venture capitalist sit on your board?
7. Are you aware of what negative control provisions (consent matters) are and the restrictions that would put on you (for example not taking on debt, not hiring someone above a certain pay grade)?
8. Are you prepared to have your existing shares reallocated by a vesting schedule, and for 75% them to re-vest following the first ‘round’ of capital you take on?
9. Are you prepared to keep raising money throughout the journey of growing this business?
10. Have you modeled out the dilution to your shareholding that raising multiple funding rounds would involve? Have you looked at any IPO filings of public companies to see how much the founders own on an exit?
11. Are you aware that you could be fired as the CEO/ founding team?
12. Are you aware of the terms ‘good leaver’ and ‘bad leaver’ and what they mean for your shareholdings if you were to leave the business?

These is a non-exhaustive list but hopefully helps as you start thinking about whether Venture Capital funding is really what you want.

Summary

More needs to be done to signpost options to founders starting businesses to make sure that they know what to expect from each different funding source and to allow them to build enduring, successful companies for the long term.

If you would like to contribute to this work, or if you have feedback, please get in touch.