Yesterday, I asked a venture capital investor this question:
“When should a software startup founder not take venture capital investment?”
He didn’t tell me that every founder needs VC investment.
Like all VCs, he knows that venture capital is for a small minority of founders and startups.
But he did answer my question in the way a professional investor thinks, not how a founder thinks.
Here’s what he said:
“A founder should only take outside venture capital funding when their own ROI of that invested capital exceeds what they could do on their own.”
ROI is Return On Investment.
That’s how a professional investor thinks.
- They raise other people’s money in a fund that will pay back those investors better than other investments. They are serious about delivering that ROI to their investors.
- They only invest in a company when they think the payback from that investment will meet their “10X” ROI.
So when a founder sells equity in their company to investors, they are “making an investment” with the equity-for-capital exchange that should PAY THE FOUNDERS BACK BETTER than not taking that investment.
But this is not how most founders think, right?
Startup founders, often desperate for cash, tell themselves things (lies?) like these:
- My startup needs money so I should take VC investment.
- Getting VC funding is “what everyone does”
- Getting VC funding always works (for founders or for investors)
- I’ve never raised money before, but I won’t get screwed.
- My startup will definitely be big someday and funding is the answer.
- If I raise $2M in funding we will definitely double the recurring revenues in our business.
- Raising a VC funding round will be easy and won’t take away major time from running my business.
Those are the common stories that founders tell themselves that make taking institutional VC capital the most expensive bet-the-company investment they have ever made.
What’s the ROI when you bet your company and fail outright?
Or the ROI when you sell the company for a smallish amount but VCs get all the proceeds (“liquidation preferences”).
When founders look at it as, “I will take $XM investment with reasonable terms and we are very confident that it will help us grow faster and increase our valuation much more than we could do on our own,” then there’s good ROI for the founder from that funding.
That makes perfect sense to me, and I recommend those founders take the funding and go for it.
But that’s now how most founders think about getting big funding, right?
Remember, institutional investors get their ROI before founders do. The house wins first. And VC investors can afford the total losses.
If you’re desperate for cash, unsure that the funding will grow your business, or are forced to take bad terms from investors, you probably won’t get any ROI on that outside investment.
VC investment isn’t bad or wrong; it’s just not helpful for most founders. Be careful what you ask for.
hashtag#practicalfounders
