Venture capital is a great solution to many startups’ finance problems, but it’s often not the best solution and, even when it is the best solution, it often works best as a part of a suite of financial solutions rather than a silver bullet that solves everything in one move.
Venture capital, including angel investment, is the most expensive type of capital out there. So why would so many people be intent on going for the most expensive option when others exist? A typical VC is looking for a return of 60% or greater on their investment – compounded annually. That means that at three years they want 4X. At five years it’s 10X. At seven years it’s 25X and at 10 years it’s a whopping 100X return on investment. All of these are 60% compounding returns.
Venture capitalists need big returns to help offset their big risks. About half of their investments might result in a complete loss of invested capital, so they need to have investments capable of being home runs in order to pay for all the losers.
There are different ways to create a capital strategy for startups who want to both grow fast, but minimize dilution and reduce the cost of capital. Rather than using just one very expensive type of capital for their startup, they may use a suite of different sources that are appropriate to the phase of development.
Early Stage – Before VC
Early stage companies have many sources of capital available to them, even if they don’t know it.
SBIR (Small Business Innovation Research), Advanced Industries Proof of Concept and many other federal and state grants are available for early research and proof of concept. Often these are expensive research projects whose risk is much greater than can be justified even for venture capital. Startups that use these sources of funds can increase their value and decrease their technical risk without any dilution to the founders.
Another source of early stage funding comes from specialty service providers. Attorneys and CPAs will often defer compensation or work out an equity deal in exchange for early work. You might be able to get your patent filed for zero out of pocket costs using this kind of deal.
Companies that are in revenue have lots of new non-VC sources of funding available. Consider accounts receivable finance to cover your rapidly growing need of cash to carry AR through thirty to ninety days before it gets paid. Some lenders will even lend on purchase orders so you can get the capital you need to buy the components you need to build your product.
If your product is a SaaS (Software as a Service) platform, then your cost of goods is going to be people, not product. Consider using Equity Compensation for all or part of your payment to your developers. There are both individuals and development companies who will swap a portion of their compensation for equity. You’ll need to have a good handle on your valuation, but why not give equity directly to your developers rather than give it to VCs who give you cash which you then turn around and give to developers?
So, there are many more types of finance options available to you than can be described here. The main point to remember is that you are not required to use just one mode of funding. Look at all of the available sources and design a suite of solutions that provides the best solution to your situation.
To learn more about how to use creative funding along with venture capital, or instead of it, consider attending the RVC’s Colorado Capital Conference November 15-16, 2016. If you’re not in Denver on those days, you can register to participate in the conference via live-feed.
More information and registration at www.coloradocapitalconference.org
Peter is Executive Director of the Rockies Venture Club, Managing Director of the Rockies Venture Fund and teaches in the Colorado State University MBA Program. Peter is co-author of Venture Capital for Dummies, (John Wiley & Sons 2013) Available at Amazon, Barnes and Noble and your local book store.