Why does Venture Capital matter?
Whether to raise venture capital is a decision about what kind of company you are agreeing to build, not simply where the money comes from. Venture funds are structured to need outsized outcomes from a few companies, so taking their money commits you to pursuing one, on roughly their timeline, with the governance and liquidity expectations that come attached. A business that could comfortably reach several million in annual profit and stay there is a good business and a poor venture investment, and founders who learn that distinction after signing the term sheet learn it expensively.
What does Venture Capital look like in practice?
Suppose two founders each reach $5M in annual revenue growing 30% a year. The one who bootstrapped owns most of the company and can take distributions or sell and do well. The one who raised venture capital at a price that assumed a far larger outcome now has investors whose returns depend on that outcome arriving, a board asking what unlocks the next order of magnitude, and a preference stack that changes what a modest sale pays the common shares. Same business, two different sets of obligations, settled years earlier by which check was accepted.
What are the common mistakes with Venture Capital?
- Treating venture capital as the default way to fund a company. Most companies are not venture-fundable and do not need to be; revenue, debt, grants, and customer prepayments fund far more businesses than venture ever has.
- Reading investor interest as validation of the business. It is validation that the business might fit one fund's return model, which is a narrower and more specific thing.
- Optimizing the raise for headline valuation alone. Terms, board composition, and how much life is left in the fund often matter more to the outcome than the number that gets announced.
- Assuming the money is the hard part. Venture capital buys time and hiring capacity; it does not buy demand, and a company that raises before it knows who its customer is usually just runs the wrong experiment faster.
Related concepts
- Venture Fund MathA venture fund has to return the whole fund from a small number of very large outcomes, which is why an investor can believe your company will succeed and still decline to invest.
- LPs and GPs (Limited Partners and General Partners)The two sides of a venture fund: Limited Partners (LPs) commit the capital, and General Partners (GPs), the investors a founder actually meets, are hired by those LPs to invest it well.
- Pre-Seed, Seed, and Series AThe named stages of early venture financing, distinguished not by dollar amount but by what the company has proven and what the round is meant to buy.
- DilutionThe reduction in each existing shareholder's percentage ownership that happens whenever a company issues new shares, whether from a new financing round or a new option pool.
- Lead Investor and the Term SheetThe lead investor is the firm that sets the terms of a round and typically writes its largest check; the term sheet is the document in which they propose those terms before legal work begins.
- BootstrappingFunding a company from its own revenue and the founders' resources rather than from outside investment, so growth is paced by what the business itself produces.