Revealing signs that you should NOT be raising risk capital

Most entrepreneurs believe they need venture capital funds to start a business, but the truth may be that they don't.

7 min read

The opinions expressed by employees are personal.

Revealing signs that you should NOT be raising risk capital
Revealing signs that you should NOT be raising risk capital

Standing outside the offices of Mercy Virtual in St. Louis, an unusually cold day, I was on the phone with two founders who were telling me about a new blockchain startup. They had a few customers and a little early traction, but nothing to indicate that there was a niche in the market. Even so, they had raised $ 3.5 million from crypto investors in their initial offer to grow the equipment and develop the product. Impressively, the $ 3.5 million they had earned were non-diluents, that is, they did not have to grant capital from their business in the same way they would have had to do so through traditional venture capital.

“We are planning to raise traditional venture capital because it is a great time to do it,” said one of the founders. “Our friends have earned $ 45 million and $ 50 million in Memorandums of Understanding (MOUs), and there is the money.”

“Yes, OK, I understand that. It is a good strategy, ”I replied. “But do you really need that money to grow the company? What is it for?

“If it's there, let's take it” was the thought of the founders.

This anecdote exemplifies how, during the last decade, risk investors have put more than $ 500 billion in startups, and that acceleration programs have proliferated as entrepreneurs have begun to take advantage of the healthy capital market. If you wanted to start a startup, many founders believed that the first step was to raise venture capital. Unfortunately, the data does not support this assumption. Only one percent of entrepreneurs can get some type of venture capital. And even more disconcerting is knowing that, of those who do, only 42 percent can get Series A financing.

Put simply: you don't need to raise risk capital to build a big business . In fact, now many entrepreneurs are avoiding these investments because of the pressure they put on the founders and the problems that focus on property dilution.

Fortunately, there are clear signs that tell you things. The main one is to ask yourself if the type of business you are building can be “backed by venture capitals” or not. Second, you should ask yourself: Does the fact that capital is available mean that the business needs it? And third, you should try to understand how much dilution of ownership and control you are willing to accept.

Can your business be “backed by venture capital”?

Recently I was sitting with a friend of mine who is starting a mobile application for people who want to spend time with other people's dogs. No, I'm not kidding. And this founder was having trouble raising capital. I told him that the market was very small and that if he expanded his concept to include the pet food and services market, he could transform his business into something that could be backed by venture capital.

What this entrepreneur could not differentiate was a business “backed by venture capital” from a “lifestyle” business. The first is a company whose business and technology model has the potential to generate substantial returns, usually 100 times or more on the initial value of the investment, and a billion more valuation. On the other hand, a lifestyle business is a company whose business can be successful, even highly profitable, but does not have the opportunity to scale in the market to a dominant position. This may be due either to the overall size of the market, or to the fact that growth depends on adding more members to the team rather than process automation.

Many starting entrepreneurs fail to identify the important differences between these two types of businesses. That an entrepreneur is passionate about a market, an idea or a particular product does not mean that it will automatically be a business that deserves a risky investment. The founders need to ask themselves the opportunity that exists to scale, the dynamics of the market, the opportunities to acquire clients, and their ability to generate places of impact through networking to know if their business is supportable or if it belongs to the category of style of lifetime. And if you are building a “lifestyle business” that you are passionate about, do it! The fact that he will not raise risk capital does not mean that it is a bad idea.

The fact that it's there doesn't mean you have to take it

Let's go back to the conversation he was talking about at the beginning of the article. Repeatedly, the founders said they were raising capital “because they could.” However, they never said how they would distribute that capital. They thought they should take it “because there it was.”

For entrepreneurs who are good at raising capital, this is a bad trap they can fall into. Smart investors seek a clear action plan for procedures, hiring, sales and investments. The best investors want to understand the way in which the capital raised today will be applied to ensure the ability of business to raise capital tomorrow. Simply lifting it “because you can” is not enough. s need an action plan to deploy capital after having achieved it.

Understand the dilution before asking for money

When raising capital, many entrepreneurs underestimate the amount of dilution they will face when integrating external investors to their board of directors. Put roughly, dilution is the percentage of property you offer in exchange for capital. In general, investors make a strong negotiation here, since their objective is to enter the company with the lowest variable valuation. This usually results in a high level of dilution for the original team that started the business. If you are a founder concerned about dilution or are not comfortable with the level of property you are going to deliver, you should think twice before raising traditional venture capital.

There are other forms of financing available. You can get money from friends or family. If you have some earnings, you can ask for a loan, or use a conventional credit card. You don't have to accept the dilution you don't like just because you want capital.

When starting a business, entrepreneurs should understand the indicators that show that they should not raise risk capital. Among these, it is essential to understand the difference between a business that can be backed by venture capital and a lifestyle business, and not take capital solely “because it is there,” understanding the dilution that comes with external investments.

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