Venture Capital versus Customer Capital: What’s right for your startup?
The decision on how to fund your early stage startup has significant consequences for founders who are navigating the avalanche of information surrounding startup financing. About 18 months ago I was looking to raise Venture Capital (VC) Series A financing for AgDNA . During the process I was discussing our progress with one of our existing private investors when he asked me “why are you prioritising venture capital over customer capital?”
I didn’t appreciate the impact of his question at the time. Heck, I’ve got an MBA. I’ve read all the startup success stories. Growing your business with VC is how it’s done. Or at least that’s what I thought at the time.
Raise cash. Grow business. Live happily ever after…
The VC Minefield
However, the reality of capital raising is much different. Once you go down the VC path, new dynamics come into play. Company valuation, preference shares, pre-emptive rights, compounding interest, board seats, shareholder dilution and the expectation of a 10X return for the VC fund.
Hmmm, did I miss this MBA class?
Nevertheless, we signed up with the team at AgFunder to get the word out about AgDNA and get in front of the VC AgTech community. We launched our campaign on AgFunder and were immediately being introduced to genuine AgTech VC firms. Perfect, term sheet here we come!
The pitch about our business started out well and became more and more succinct with every presentation. Although after about a dozen pitches I could see a trend beginning to take shape. Essentially every VC put AgDNA in the AgTech “software” bucket. This meant a lot of energy had to go into differentiating our value proposition from our competitors along with educating investors on the merits of software in agriculture.
I soon learned VC doesn’t automatically translate into expertise about your sector. There are some very knowledgeable VC firms and some that are still trying to figure out how agriculture works and what AgTech means for the customer.
Side note: if you’re an AgTech startup looking to raise capital then contact AgFunder — great team, great contacts, great results.
The Term Sheet
After plenty of pitching, AgDNA received several term sheet offers. We accepted the one we thought was the best fit for our business. It was a corporate VC as lead investor with two other VC funds co-investing. They gave us a fair valuation with standard VC terms.
Remember the plan. Raise cash. Grow business. Live happily ever after…
However, within a week of signing the term sheet the lead corporate VC appointed a new CEO to their parent company and many projects within their organisation were put on hold. Including new investments by their VC business unit.
Subsequent changes in management by the incoming CEO resulted in changes to our term sheet. Moving the goal posts this early on in the relationship felt like a sign of things to come. So we decided to reject the revised term sheet and go our own way.
Back to square one.
By this stage almost 12 months had gone by and I was reminded once again of the question “venture capital versus customer capital”. The answer was now much clearer to me. Customer capital (aka sales revenue) was the most obvious and efficient source of cash to grow the business.
Customer capital doesn’t come with all the fine print of venture capital. It doesn’t need to be paid back and it forces you to focus on the core of your business. But sales channels take time to develop and the seasonality of agriculture means cashflow can be lumpy.
Realigning the business toward customer capital and organic growth would require laser focus.
Every startup needs working capital to function, to grow the team, to build a great product and to delight it’s customers. So we raised additional seed capital from private investors within the ag sector. This allowed us to remain true to our core beliefs around AgTech and it allowed all shareholders to remain on equal terms with only ordinary shares on issue.
Most importantly, it allowed the company to remain 100% focused on the customer.
I am still a firm believer in the role of VC and the impact it can have on the growth trajectory of a startup. But it must be timed just right.
Venture Capital is like rocket fuel. Switch to thrusters, press ignition and hold on as the acceleration compresses you back in your seat. But be careful, accelerating your startup too early or in the wrong direction can be disastrous.
I have watched numerous AgTech startups raise capital too early. Their product market fit was unclear and their revenue models questionable at best.
Build it. Nail it. Scale it.
This is the formula for many technology business success stories. Accelerating your startup too early with VC finance could have long term unintended consequences. At AgDNA we elected to make sure we are well into the “Nail It” phase before reconsidering VC backing.
Customer capital in the form of sales revenue is the cheapest type of financing for any business. The ability to grow revenue to the point where the company is breakeven and ultimately profitable can provide a lot of flexibility and freedom to operate going forward.
With customer capital you have options. You can continue to grow organically, or you can consider raising venture capital in order to accelerate growth and “scale it”. And with a healthy amount of customer capital you can explore VC on your terms — because you want to — not because you have to.
Of course the decision to take on VC finance and its timing is different for every startup and personal for every founder. But if you’re looking to raise capital for your startup ask yourself “venture capital or customer capital”?
You might find that focusing your energy on the customer and building a profitable business is the right answer in the near term. It might not be as glamorous as VC, but long term it might be the best decision you ever made.
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