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The Miscalculations of Raising Venture Capital

The Miscalculations of Raising Venture Capital

Venture capital has been booming for 15 years.

Founders have been pitching VCs and begging for a loan for a long time since the invention of banking. Actually, raising from VC is worse because founders aren't getting a loan.

Founders have been miscalculating the tradeoff between bootstrapping and capital raising. There's been a lot of different term sheet structures but usually, the VC will ask for protections like preferred shares, board seats and other stipulations.

As a founder giving up equity should be treated with absolute care. That's sharing ownership in you, VC's don't make you successful. They support with you dollars and words.

But most startups aren't actually VC backable. VCs play the odds, they build a portfolio. For every 10 losers, they need their winners to deliver an outsized return.

The reality of your startup is unless your goal is to become a monopoly or create a seismic paradigm shift in how the world works. VC isn't for you.

The pith of startup ideas has the potential to be nice medium-sized businesses. Small-medium scale successful businesses that generate $15-30K in profit per month. VCs are not interested in returns at that scale.

Naive startups founders get tunnel vision, courting VCs and perfecting their pitch deck. Hey, it's great to have the validation of a known investor and VC firm. They do bring their set of tools, their smarts, network and other supporting resources.

Some founders over index their effort on storytelling to investors when it would be better served to customers.

So how are founders miscalculate the tradeoff?

If you truly believe your business, against all odds, has a real chance at massive success (100x). Would you really split that lottery ticket? At the tail end of an 8-10 year journey with <15% equity. As a standalone, banking a few million dollars does sound great. But that could've been $100M or even $300M.

When you look at your assets like skill, time and equity as chess pieces. A decade of founders has viewed their startup's equity as pawns. Unknowing to them that pawns can become queens.

If you know anything about chess its that pawns are crucial in the end game phase.

If you saw the true value and probability that your pawns can be promoted to queens then you would hardly part ways with them so easily. But the tension lies here, VCs will not value your equity as queens.

In fact, mathematically they can't even if they really believe you can do it. That's because VCs run large portfolio risks. They need outsized gains from their winners and they need to outperform what their limited partners (fund investors) can achieve in the public markets (stocks and bonds).

New founders would be happy just to succeed or have a 2-3x outcome. VCs are geared towards home-runs > 1,000x.

But Terence, my startup still needs funding to build an MVP and run marketing!

I hear you. To you I say, ship your damn prototype/mockup. If you're not embarrassed you've shipped too late. Get feedback early and start those conversations ASAP. Pre-sell, early release, blueprint, Kickstarter even seek angel investors.

The odds are always going to be against you, with or without VC money.

Now there is an exceptions list for raising VC is short:

  • You're in a highly technical and costly business e.g. AI, robotics or biotech.
  • You're taking on a winner-take-all market (speed and time to market wins)
  • You can't solo win and need a king-maker
  • The end game is being strategically acquired
  • De-risking by bringing in outside investors

Look, not many inexperienced founders make it to the other end of the field. But when they do, do they repeat the play or do they do it differently?

Whatever you choose, I believe in you and hope you succeed.