Why Venture Investors Need To Start Paying For Inventory
We hear regularly from frustrated early-stage founders who struggle to raise enough because investors do not want to fund inventory. I used to echo that widely-accepted nugget of VC wisdom and tell founders to secure non-dilutive venture debt or a credit line for working capital to pay for inventory purchases. But I wish I didn’t have to.
I want to suggest to my VC peers that funding inventory can be a good thing. Let’s look at a potential scenario.
Example 1: Should A VC Fund A Small Seed Extension
A hardware startup raises a $750k round to finalize design and pay for tooling and inventory. They have $100,000 in orders to ship to early adopters and are looking for an additional $300,000 to produce extra inventory. Margins are 50% and the company can activate a SAAS model that generates the equivalent of 1 unit in revenue over 24 months. To simplify the math, let’s assume that customer acquisition and operating expenses are negligible, inventory converts to revenue in 1 month, SaaS has 0% attrition, and hardware has no returns.
Should a VC fund this? The accepted VC wisdom says the margins are too small, early backers are too few, the additional money will dilute the founder, and SaaS revenue is too early. It is easy for those VCs to pass, and we think they are missing out.
A founder can convert that investment into $150,000 cash and start to live off the SaaS revenue, reaching $3 million sales in two years by recycling cash flow every 3 months into a new purchase order, as illustrated below:
We could factor back some of those assumptions where cash will be burned quickly, but in isolation you can start to see the case where paying for inventory is a good thing. At MiLA Capital, we see founders like this all the time and we plan to write bigger checks to help founders get to escape velocity.
Example 2: Should A VC Fund A Post Seed Sized Check In The Same Company
Hypothetically, what if the investor gave the founder even more money for inventory? The company is at $3M in sales at the end of year 1 and $10M in year 2.
So What Does This Mean?
In the past month, we have spoken with many startups who have strong demand for their products. They have been focused on production and demonstrated an ability to sell. They hustled to get to where they are today and their customers want them to succeed. They have factories waiting for the next order, but not enough cash to fund that order.
The next time you are a participant, or spectator, in a situation where an investor does not wish to pay for inventory, we hope you speak up. Remind the investor that not all inventory is created equally. A strong cash pile for inventory may be just the thing to get a company with strong product market fit past the death-by-cash flow.
