It is hard to argue with the following two facts:
It’s easier to earn lots of money if you have access to lots of money.
It’s easier to lose lots of money if you have access to lots of money.
Venture Capitalists provide an access point for winning big or losing big. Many of you already know that three out of four venture-backed startups fail. This means that VC’s count on one startup to score a large enough bounty that loosing the other three startups doesn’t matter to them. As I mentioned in my last post, angels are not really gambling if they play the smart odds. VC’s aren’t really gambling either. They’re just maximizing the upshot while minimizing the risk. This is like the old-world investment in boats to bring gold back from the Americas. If one ship came back filled with gold and three sank, the investor’s return on investment was huge.
For those of you that have read my Startup Studio 101 series, you may know that I believe validation takes two fundamental forms: hypothesis testing and stage gates. Hypothesis testing allows startups to quickly iterate towards a better problem-solution that will enable scalable growth. For example, I could test if teenagers like a pizza slingshot by talking to teenagers. Stage gates are an old-school philosophy whereby, if you accomplish X, you can do Y. In the old days, if you wrote a thorough business plan, you might be able to form your company. With the adoption of the lean startup model, stage gates have almost died out. Interestingly, the investor stage gate has become more entrenched than ever. All to often people say stuff like, “If we can’t raise series A, we’re done.” This is a VC stage gate.
VCs Are Your Friends
VCs are your friends. If they are not, you have four choices: 1) bootstrap your company’s growth, 2) grow your company slower, 3) change your outlook/access to VCs or 4) throw in the towel. VCs are not your only choice. They are just the easiest path (for some) to winning big. Ideally, both you and the VC win big on a joint investment. Sub-optimally, the VC will pass on your investment – but may invest on your next venture. Sub-sub-optimally, you both loose on this venture – but they may invest on your next venture. Worst case, you piss each other off and both of you miss out on this or future ventures.
VCs invest in dozens of startups over the course of their career. If one in four venture-backed startups succeeds, the VC wins over and over again. Founders create seven startups in the course of their life if they’re tenacious. If one in ten startups win, they may never strike gold. Or the founder may strike gold once and loose it all on their next venture. Herein lies the natural imbalance of the founder-investor treadmill. Entrepreneurs pour out their heart and sole into startup after startup and may win. VCs bleed out check after check and win. This causes angst for some founders. It shouldn’t. VCs are obligated to win for those who’ve invested in their funds.
Expectations are everything. Entrepreneurs are expected to be fully committed to their startup for the long haul. Once a VC is in, the VC is also in for the long haul. Getting an investment back out of a startup is hard to do without an exit. However, a VC isn’t obligated to re-invest in the next round. Most VCs hope that they will have the opportunity to reinvest in series B, C or even G. They will get more and more equity in the startup each time. But, they won’t rescue a dud investment by piling on more money. At a certain point, it is the VC’s responsibility to stop backing a given startup. Recall the stage gate conversation above? We should expect the entrepreneur to be committed to the startup and the VC to be committed to hitting the fund’s goal for return on investment.
Get Your House In Order
Startups typically have a fly-by-the-seat-of-their-pants quality. Most startups fail to think about structure and process in favor of “getting stuff done.” In fact, many investors also encourage this behavior. But nothing is quite as valuable as having your books in order, your HR properly handled and your legal docs flawlessly executed. I’ve seen what a mess it is to unravel legal or financial rats nests. If you go to a VC, have your house in order. Wooing a VC without your ducks in a row wastes everyone’s time. Good investors always do their due diligence. They will find your rats’ nest unless you fix it…
Studios and VCs
Many people ask me how Startup Studios interact with VCs. Like I’ve said before, each startup studio seems to be unique, so the answer varies. Some studios act as their own VCs, providing follow on rounds. Other studios require external rounds as part of the validation. Boulder BITS follows the latter approach, so we encourage VCs to come in and look around. We institute stage gates throughout the validation process, so all Boulder BITS startups can clear the appropriate hurdles before they ever talk to VCs.
Because we are friendly and open to VCs, there are fewer barriers to follow on investment. Boulder Bits increases the odds of success for entrepreneurs and VCs, so the treadmill works to everyone’s benefit. Our founders are evaluated, and we only work with committed, competent entrepreneurs so the commitment expectations are met. We also support the startup, providing best practices and structure so the entrepreneurs can focus on “getting stuff done.” This ensures that the VC’s due diligence won’t reveal any unexpected surprises. While Boulder BITS takes a slice of the pie, we also ensure that the size of the pie grows. It’s a win-win.
- It is estimated that 40 percent of venture backed companies fail; 40 percent return moderate amounts of capital; and only 20 percent or less produce high returns. (National Venture Capitalist Association)
- It’s also opened the door to more female entrepreneurs, she said. The VC industry hasn’t had a good history including women, let alone investing in their companies. Many angels are taking a different view and see female-led businesses as a potential area for investment that’s largely untapped. (Greg Avery)
- The software sector dominated the U.S. venture capital investments in 2015, with 41 percent of the market share. (Statista)
Author: Jesse Lawrence
Founder and CEO of Boulder Bits. Sci-fi lover, game theory strategist, and idea generator.