VC Overdoses vs. Efficient Entrepreneurship.

From Pieter Welten – Prime Ventures (@pieterwelten)

Today, there is a lot of venture capital available in the start-up ecosystem. As a result, it is a good period for entrepreneurs to raise capital in order to fund their high-growth ambitions and chase their dreams. I heavily encourage this, because venture capital could help you accelerate growth, attract (senior) executives, experiment with growth levers, give comfort to your customer base etc. Moreover, the vast majority of the most successful and well-known tech companies in the world raised venture capital (I actually wrote a blog post about this)!

I realise, though, that I sometimes start to believe that some entrepreneurs view a fund raising process as a metric of success. The larger amount they raise, the more ‘successful’ they are. And that’s what they want to achieve in the existing market, i.e. raise a large amount of capital at a relatively early stage. The fact that there is so much capital in the market, allows this kind of behaviour. Overcapitalisation, though, has downsides. For instance, you can create a culture of operational inefficiency, hereby creating high(er) burn-rates and less (shareholder-) value.

Lets take an example:

You have two companies, Company A and Company B. Growth is fuelled by sales and marketing spend and Company A grows by 200% y-o-y and Company B grows by 100% y-o-y. At first glance you’d argue that Company A is more interesting since it is simply growing faster. However, if you realize that Company A spends 3x as much on S&M compared to Company B, than you would argue that Company B operates more efficient and is a more appealing investment opportunity. Their ‘S&M efficiency rate’ is better, hereby creating more shareholder value (as the company will be more profitable). It is not about growth, it is all about profitable growth. But with a well-funded balance sheet you might forget this.

Jim Goetz, a VC at Sequoia Capital, once said in an interview that ‘the more money you raise, the less value you create’. I totally agree with him (although I realize that it is difficult to disagree with this legend). You shouldn’t raise too much capital to scale something that isn’t scalable or not (yet) optimized. If you can’t convert $1 into $3, why would you be able to convert $10 million into $30 million? Fix that first, then raise. You can also probably command a better deal! Additionally, a ‘VC overdose’ could hit back (in the form of a ‘discount’) at exit (acquirers simply prefer capital efficient businesses) or lead to excessively high valuations, since large(r) rounds tend to come with aggressive valuations. The latter is fine when things go according to plan, but in a less promising scenario it will become more difficult to raise additional funding at a higher valuation and/or could trigger anti-dilution clauses in case there is a downround.

Perhaps we start to believe that you have to raise a lot of money in order to become ‘successful’. These days you read a lot of stories about fast-growing, well-known companies that raise tons of monies and we all seem to love to read those stories. According to research, the median privately-funded unicorn has raised a whopping $284 million! Unfortunately, we all tend to forget that there are some great companies that have build large, sustainable businesses without having raised so much money. MailChimp built its company without any external capital (yes, that’s possible) and companies like Braintree, Shopify and Takeaway.com raised much less whilst triggering billion dollar valuations. It is possible. Therefore, when it comes to fund raising, my mantra is ‘less is more’, because what I see is that efficient entrepreneurship will get rewarded at the end of the road.

I said it before, there is a lot of capital in the market. To me, it sometimes feels as if there are more investors than entrepreneurs out there. We also all seem to be chasing the same deals. The result is overcapitalisation and aggressive valuations (please Google ‘technology bubble’ and you know what I mean). I don’t believe this trend is in the best interest of the industry or to each individual company. Overcapitalized companies could set the wrong priorities (e.g. prioritizing growth over figuring out the right business model) and high valuations often fire back (since the vast majority of start-ups are often unsuccessful, unfortunately..). We should also not forget that it takes time to professionalize and mature any company. Excessive capital won’t be able to accelerate that process, we can forget about that. Therefore, my advice to entrepreneurs is to raise enough capital for the next 18-24 months that you can deploy efficiently. I do understand that a proper ‘war chest’ allows you to grow fast and aggressive, but you should grow in a capital efficient manner. Don’t raise mega rounds to fuel your rocket ship, because in my opinion VC overdoses often seem to be cursed and a lot can go wrong in space.