Venture Capital Is Not For Every Startup

Understanding venture capital and which type of financing best suits you and your business

The NY Times circulated a piece this past week discussing a trend of founders declining venture capital. I thought it’s worth cutting through the noise to address venture funding as it relates to supply chain startups, specifically. To start, not all businesses are created equally and more importantly, each founding team have their own dynamic as it relates to ambition and growth capability. These attributes ultimately impact a company’s financing strategy.

As Josh Kopelman at First Round puts it, venture capital is “jet fuel” and a very specific set of companies fit the criteria to take it. Peeling back the onion, not all venture funds and specifically, seed funds are created equally — smaller funds have smaller exit value needs vs their larger counterparts. The driving factors ultimately boil down to check size, ownership, and reserves. To detail, more a fund owns per dollar deployed and the better they can maintain that ownership, the greater tolerance for “smaller exits.” This requires a fund to “go big, later” or “go early and lock down ownership” — not easy in the reality of things. A simplified example: $10M with no expenses, 25 portfolio companies, $400k for 5% ownership, no reserves so assume 50% dilution before exit, oversimplification of the return distribution, not taking a preference stack into account. Most GPs target 3x returns over a 10 year fund life. So what does that mean? That means that the fund needs $400M exit value to return $10M and a $1.2B exit value for $30M. Turns out dilution is nobody’s friend. So what does this mean for founders in the space?

The diversity of functions, problems/solutions, and business models make almost the entire spectrum of financing options viable in supply chain. The industry is typified by fragmentation, service-first thinking, physical goods, and short time to revenue but long time to critical mass (and scale). This generally means that venture capital is ill-suited for most businesses due to product, go-to-market, revenue model, and timing issues. Simply put, VC is good for businesses that have 1) a large addressable market/a market that’s fast growing, 2) a founding team that gets the demands of VC, and 3) an opportunity that can reasonably generate a healthy return for the investor (assume 3x minimum in 10 years). Other factors tend to include: large product investment requirements, path to product/market fit, and scalable go-to-market (the latter two are usual not evident/fully clear at seed). It’s great that more financing options are becoming available. VC as the status quo, go-to for funding is incorrect. So what are the other options?

Money comes from many sources and full of nuance: bootstrap/self-funded, high net worth investors, private equity (majority investors), bank financing, specialty lending, grants, revenue, and VC.

Bootstrapping is great for businesses that have relatively fast time to revenue and for founders who want to own most or all of their business. I see many who are fortunate to have friends/family with the means, take some dilution or a loan to juice their progress without being beholden to a certain return profile. Freight brokerage, mid-market SaaS solutions are a great example of businesses that could grow this way.

High net worth investors (usually angels or family offices) are great sources of capital that tend to be less sensitive to returns. Asset-based businesses or those that require manufacturing can be a fit for this group. It’s worth noting that neither of these aforementioned sources preclude one from raising venture and they aren’t exclusive to venture backed companies despite being associated with them.

Private equity has long played in supply chain. They tend to seek tenured operators, majority positions with control rights, and write large checks up front in the hopes of 7–10 year gains — smaller firms tend to be more open to minority investments. We’ve seen freight forwarders, brokerages, and increasingly, SaaS businesses attract PE.

Bank financing and speciality lending is debt — an obligation on a company balance sheet that can also include minimum cash payments, and performance covenants. It’s usually harder to come-by for startups but can be a fit for asset heavy industries, manufacturing, and where factoring (fronting cash for receivables) is advantageous. I would note specialty lending can be highly bespoke so can be driven off revenue or growth metrics.

Grants are usually great for really early, high-tech products but requires a special approach to earn. We do see this as a precursor to venture capital or other funding in the case of — robotics, energy, applied ML solutions.

While not an exhaustive perspective, it should be clear that VC fits a minority of businesses in this sector and the spectrum away from VC. “VC raised” is an ego metric and not all business need VC to grow to a critical mass. Furthermore, founders that raise VC are not any more special vs those who have the self awareness and realization that they’re/their business are ill-suited for it. The easiest way to attract outside capital ultimately is your customer’s dollar. Revenue is the best source of capital and if you’re earning it consistently and acquiring it efficiently, that generally brings investors of all types to your door.

Originally from Issue 49 of the Dynamo Dispatch.

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