Why VC money may not be a good idea for funding your startup

Lots of people are playing the startup game these days. It goes like this:

  • Come up with a really cool idea (preferably involving technology)
  • Make a prototype and start a beta trial
  • Try to find a VC or Angel investor to throw lots of money at you so you can continue to develop the product (and pay for things like rent, food and a new car.)

There’s two things wrong with this strategy:

1. The numbers don’t work for you

In the US (arguably the largest VC market in the world) about 1,500 companies receive VC funding and 50,000 receive Angel funding per year, according to Venture Capitalist David S. Rose of Rose Tech Ventures. And half of those that do get funded, go out of business in a couple of years.

If you are relying on investment funding to grow your business, that gives your business a 1% chance of succeeding. If you go down this route, you will need to work close to full-time on capital raising as well as working 60 hours a week building your startup. Do you really want to work so hard for such low odds?

Whichever way you do the maths, it’s not a good return on investment for you.

2. It can encourage you to be lazy with your strategy and implementation leading to business failure

A few weeks ago, I was speaking to someone who had developed some Saas Software. He had finished the product and on launching it found that he wasn’t really sure who his specific target market was. Not only that, the potential customers who were trialing it for him were telling him that it was nice to have but it didn’t solve a real problem for them.

He was looking for half a million US dollars to develop the ‘full’ version of the software. In other words, he wanted a saviour on a white horse to chuck a lot of money at him in the hopes that it would solve his problems.

Of course, no investor is going to bite.

But instead of saying, “Of course, how ridiculous,” we should stop and pause.

Many startups I talk to, are in exactly the same boat and are pursuing the same strategy.

They think their product is better or that somehow they are more special so they will get investment. Human nature being what it is, we are biased towards our own business and apt not to see the truth even when it is obvious to others.

What often happens, sadly, is that these people run out of money, get disillusioned and quit. If they had approached their business a different way, they could have had a different result.

What if this programmer’s story had gone something like this?

  • Before he wrote a line of code, our intrepid programmer spent time meeting and talking to real people in his target market and finding out what their needs were. He also talked to industry experts and read research reports to validate the ideas he discovered during this process and to really understand the market he wanted to enter. During this time, he discovered lots of information he didn’t know before that meant he could really create something that his market wanted and needed.
  • Now that he had discovered a real need and a way to solve it, our programmer built a business model around his solution. Why do this first? To be sure that he could actually make a business out of this opportunity.
  • Next, he designed a simple product and how it would work including the user interface (but still hadn’t written any code at this point.)
  • He put up a website with some mocked-up screen shots of the program he had designed and asked all his industry contacts for presales. Or, he could have run a crowd-funding campaign which is essentially the same thing. (Note that to take money before handing over a product is illegal in some countries.)
  • Then he put some code together to create a product that had the two or three most important features his potential customers wanted.
  • Once he had some paying customers, he added more features to the product, did more marketing and the business grew from there.

Could he do this without investors? Absolutely. Does he get to retain the equity in his business? Absolutely. Is his business more likely to survive? Absolutely.

VC funding is not a lottery, but many entrepreneurs think of it like it is – that’s it’s just a matter of being lucky. It can be great, but it’s not right for every business and securing it is by no means certain.

There’s nothing wrong with making something and hoping people will like it, but if the result you really want is a functioning business, then aiming for VC funding will not necessarily get you there.

There are many ways to build a business without outside investment, no matter what industry you are in.

But that’s a story for another post.

Action:

Are you telling yourself the truth about whether your business is suitable for VC funding or not? Are you biased?

Have you done market research or are you making something & hoping that people will like it?

What are the most important results you want from your business? Will VC investment help you achieve those or is there other alternatives you can look into?

Further Reading:

Funding a Startup without VC by Anil Dash. This article is great and outlines alternatives to VC funding.

This article explains the expectations on a company funded by VC money – and then goes on to explain an alternative form of investment – equity crowd-funding.

Join the conversation

Have you chosen to pursue VC funding? Why or why not? Share with us in the comments.

Or use them to create a little bit of extra motivation and accountability to get your action task for today done.
And I would love you to join me on Facebook or Twitter.

Image used courtesy of  blakeimeson under Creative Commons license.

Comments

  1. Hotman Sihombing says:

    absolutely true! “Keep going & keep healthy, starting with what you are, your very firstly money will show you what money then”

  2. Jen says:

    This is not always true. Sorry! but I disagree.

  3. Agree with the problem section – funding brings its own problems and challenges so avoid it if you can.

    Not sure if I agree with the solution though. That approach of market research and building a non-working prototype/design may work for certain products, but for most applications its better to create a working prototype and iterate with early adopters.

    • If you have the resources or skills to build a working prototype, that’s a great way to go.

      The market research is important in the beginning to make sure that the problem you are solving is large enough for you to make money in that niche. It also starts to give you insights into what your customers want so the solutions you come up with are more targeted and more likely to be successful.

  4. Amanda says:

    Real crowdfunding – aka rewards crowdfunding – is the only way to raise cash while testing the market potential of your idea. Take a look at how it’s done http://www.bloomvc.com

  5. Totally agree. Try bootstraping first. Finding paying clients & finding investors is exactly the same level of difficulty. I’ve done both in the past & now will only bootstrap. More control, less stress & more predictable — as far as I’m concerned.

    Love this blog 🙂

  6. I chose not to pursue VC funding. First of all, I have a vision for my business, and do not want it clouded or changed by anyone else who has a stake in my startup. I have sold some of my favorite assets to pay for the project, but it is worth the risk! I think if you really believes in your idea, you will sacrifice for it. Why ask someone else to take a risk you are not willing to?

    Of course, mine is not the path for everyone……

  7. Thanks for the article Susan. I totally agree that VC funding isn’t something to go after in the early stages – but in terms of the suggested programmer story – I think thats highly unlikely to ever happen for most programmers.

    Its definitely great to get out and speak to potential customers first. Totally agree that you should to establish a customer pain, and how they’re solving that pain currently…and validate if there is a market at all… But its also great to get a working prototype if you can.
    (I wonder if products like Google Search, Twitter, Facebook, Instagram, Whatsapp wouldn’t have passed the paper prototype phase)

    Often unless you’re working with a product designer, its really hard to build a simple product interface from scratch. Even on paper. Sometimes (if you’re a programmer) the best way is to hack together some coded prototypes and that helps establish what the challenges are for the basic UI. I think it all depends on your individual skill set. You may need some cash in order to get over the line with those.

    Similarly if you’re not experienced in business – thinking through business models isn’t something that comes naturally. Sometimes Angels will be the best people to help with this, and getting the right angel investors on board is a great help here. Raising a crowdfunding round is actually pretty complex and in a new marketplace really needs marketing behind it to take off.

    Ultimately I’m suggesting that depending on your skill set different people will start startups in different ways – And it really does seem to take a combination of skill sets to launch a successful product. So finding networking and finding co-founders would probably be my advice overall.
    And funding might be required to hire them…

    ps
    I think its also worth saying that some people aren’t actually as interested as their business surviving as they are in “going on the startup journey” for the experience or just to be out of the 9 to 5 for a while. So there will always be a ton of people who follow or try to follow the VC path off the bat without gaining traction, but I guess that’s becoming less and less viable these days.

    • You make some really great points here Colin. Thanks for sharing.

      I agree about needing a lot of different skill sets to startup successfully and that different approaches might be necessary for different businesses.

      In an ideal world, we would be able to get funding to pay for those. The reality is that the odds are against entrepreneurs trying to find investors unfortunately.

      What I want entrepreneurs to understand is that we need to bite reality and be creative about how we find the cash to get our startups off the ground.

  8. Totally agree.
    In fact recently I heard John Mullins talking on the Customer Funded Business http://books.google.com/books/about/The_Customer_Funded_Business.html which I think really backs up your point.

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