To VC or Not to VC

Rick Ellis whose company pmachine publishes Expression Engine (the weblog/CMS software which runs this site) writes:

A common decision faced by small companies like mine is whether to seek outside funding to help growth.  Venture Capital firms and Angel Investors are beginning to look at software and technology companies again after the bubble burst a couple years ago so it’s tempting to pursue these deals.  I was reminded of this yesterday in an email exchange with a friend of mine in which he asked why, in light of a certain competitor with a VC deal, aren’t we more aggressively pursuing funding?  “Wouldn’t you love to have a big staff of programmers doing your bidding?” he asked.  “Well sure”, I answered, “if it were only that simple.”.  It’s not.

The cold reality is that at least 70% of funded ventures fail.  When you scale up your expenses hiring staff, leasing office space, buying infrastructure, and paying for advertising - without the revenue to support it - the likelihood of your long terms success decreases drastically.  Most ventures never recover from the high cash-flow burn rate. 

Yet VCs need a high level of risk to make the investment worth it.  At least 3 out of 10 companies will fail so they rely one or two very big hits to pay for all the other speculation.  In business, you generally don’t hit a big home run being conservative. 

On the plus side for angel or VC investors, if you get the right one they can provide perspective and experience as well as depper pockets than other partners may have. In one company I am familiar with, quarterly board meetings that include outside investors do provide a focused attention to our finances, budget, sales projections, etc. They also provide a time when we are, to an extent, “selling” the vision AND the detailed execution of the company to outsiders.

I attended a breakfast meeting with Andrew Sherman, a lawyer with McDermott, Will & Emery [ http://www.mwe.com ] in Washington, DC. He is also an adjunct professor at Univ of Maryland. There is a strategic pyramid for capital formation that runs from your own money/resources at the base (the bootstrap mode) to money from family, friends, and key employees, SBA loans and small biz commercial lending, then Angels. Venture Capital is higher up the pyramid. Indeed, it doesn’t make sense to consider VC unless your capital needs are such that it cannot be bootstrapped, or borrowed. Why give up the control?

Andrew also recommended the book Every Business Needs an Angel by Cal Simmons and John May. The key here is that if financial projections show that the company will need capital to grow, an angel investor who knows the industry, may be retired but also interested in a “fun” project can be the right and best next investor up the pyramid. Choose the right one and if, just if, your business evolves to be the type that may need additional investors through a private placement or VC, and leading to an IPO if that is the path, you will have broadened the company’s expertise in the key area of capital formation.