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Five Reasons Not To Raise Venture Capital capital is not a rags to riches story. It’s the inspiring tale of redeploying resources from a lower- to a higher-performing asset classFive Reasons Not To Raise Venture Capital, by Rachel Chalmers | Model View Culture

Stashed in: 106 Miles, Venture Capital!, Funding, startup, Startups

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From the start this article is brilliant:

1. You probably won’t get a fair hearing.

The seductive narrative of Silicon Valley stars a genius-hero who goes on a journey, overcomes myriad obstacles, has a flash of insight and is rewarded by wise and benevolent investors with Series A funding.

This narrative is bullshit, but it’s everywhere. Take Marc Benioff’s book Behind the Cloud. Not to pick on Benioff – I’m a fan, his foundation does good work and his book contains its own chapter on why you shouldn’t raise VC – but he started on leave from his executive gig at Oracle, with $6m in savings (!!!), $2m in seed money and the mentorship of Larry Ellison. That makes it difficult to buy into any portrayal of him as an underdog -- but it also offers some insight into the kinds of people that do get funded.

Silicon Valley is a meritocracy in the same way that the Ivy League schools are: it helps to be smart, but it helps just as much or more to have the right connections. The game is rigged. The pathology of Silicon Valley is that the winners have so much ego invested in pretending that it isn’t. It’s hard for people who pride themselves on their exceptional smartness to acknowledge the fact that they are much luckier than they are smart.

5. Venture math is a harsh mistress.

This is the biggie. VCs aren’t unintelligent. Nor are VCs evil (not all of them anyway). They’re not even necessarily misaligned with you. What they are doing is optimizing for a very specific outcome. Share that alignment, or don’t take their money.

Besides being custodians of the fund and therefore honor-bound to seek the best outcomes, investment managers are compensated in part by carried interest. Carried interest is a cut of returns to the fund after (a) all capital has been returned and (b) the fund has met an agreed-upon rate of return. Let’s say the VC firm has a $150m fund and a preferred return to investors of 3x, or $450m. The partners in the VC firm don’t even start earning their carry check until that $450m threshold has been reached.

What does this mean for you, everywoman entrepreneur? Let’s assume this firm has offered to invest $15m in your company in exchange for 15% of equity. At that rate, said VC firm can make ten such investments. We all know that nine out of ten startups fail, so the VC is betting that one of the ten of you can return the fund, and then some.

What do you have to do to make the VC’s 15% of equity worth in excess of $450m? We are now talking about a $3bn outcome.

Whatever it is you have to do to earn this – take the company public, somehow impress Mark Zuckerberg – your investor/co-owner is now focused on persuading you to do. That’s why they’re starting to ask if you would consider moving aside to let an experienced public-company CEO take over.

By the way, the odds of achieving a $3bn outcome are so far from being in your favour, it’s absurd. Not winning-the-lottery absurd, but an order of magnitude worse than that old one-in-ten rule of thumb. Let’s leave aside the outliers like WhatsApp and focus on enterprise software, a business I know and one that’s slightly less subject to the whims of wanton Gods than consumer-land. As an industry analyst, I covered 1054 enterprise software companies over a 13-year span. Of these, 75 were incumbents or enterprise end users of other vendors’ software, so let’s say 1000-odd were venture-backed startups. Where did they all end up?

Well, 188 of them were acquired, in deals that ranged from the sublime (Citrix paid $500m for XenSource, which had trailing 12-month revenues in the $1m range) to the ridiculous (many, many face-saving exits of failed firms consisting of a nominal fee in exchange for their patent portfolio.) Note that an exit in the tens of millions, which is a champagne-and-confetti Retirement Level Event for the owners of a bootstrapped company (like Sleepycat Software or Platform Computing), can be a disaster for a venture-backed firm. In particular, since the investors own preferred shares (which means they get paid first) and the employees own common stock (which means they only get paid if there’s anything left over), the people who actually did the work can walk away from a multi-million dollar acquisition with nothing to show for it but sadder and wiser hearts.

Back to my cast of one thousand: 28 of them failed so hard they don’t even fog a mirror any more. Google their corporate site and get domain-squatter linkspam. No face-saving exits for them. I won’t name names. Eight went public: eight out of a thousand. Their names are Opsware, Rackspace,, ServiceNow, SolarWinds, Splunk, VMware and WorkDay.

What this means is that you are more than three times as likely to crash your startup as you are to ring the Nasdaq opening bell. Your chance of utter failure is around 3%.

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