what i wish i’d known about venture capital when i was a founder

When you are building a business – particularly if it's your initial undertaking – it's probable you won't have the opportunity to thoroughly investigate the operations of venture capital firms. Securing funding can divert founders’ attention and potentially hinder the company’s progress during its formative stages. However, beginning to understand VCs only after you’ve commenced fundraising efforts is often too late.

Entrepreneurs frequently commit common errors during the funding process. A primary error – and often occurring in tandem – is securing an inappropriate amount of capital or seeking it at an inopportune moment. This combination frequently leads to founders relinquishing too much equity prematurely or failing to obtain sufficient funds to progress to the subsequent funding round.

Another common misstep is concentrating efforts on a single potential investor too soon. I personally experienced this challenge. I had received a term sheet (a preliminary, non-binding agreement) for a €2.5 million Series A investment, completed the due diligence review, and received approval from the investment committee. However, a dispute raised by an early investor in my company caused the prospective investor to withdraw their offer. A survey conducted by Point Nine Capital revealed that the two most challenging aspects of raising venture capital are a lack of clarity regarding the stage of the fundraising process and uncertainty about the reasons for VC rejections.

Conversely, a strong understanding of venture capital will prepare you for the process, help you identify the ideal investor profile, and, most importantly, allow you to maximize the long-term value of your company’s equity. Research indicates that founders who successfully raise larger amounts of venture capital ultimately retain a greater ownership percentage when their company reaches the point of an initial public offering. The learning process is demanding, requiring not only an understanding of the venture capital landscape but also of the individual investors involved. Therefore, I want to share the key insights about venture capital that I wish I had known when I was a startup founder seeking venture funding.

1. Focus on the Optimal Funding Amount and Timing

For startups, achieving two key objectives is paramount: first, establishing a strong product/market fit, and second, developing a growth strategy that is both profitable and capable of scaling. Successfully reaching these points significantly lowers a startup’s risk profile, which is typically reflected in its valuation. As a founder in the early stages, safeguarding your equity requires securing smaller funding rounds while your company’s valuation remains relatively low.

Conserve your financial resources until you’ve minimized the risks inherent in your early-stage venture. Subsequently, pursue more substantial funding once you possess concrete proof of a robust product/market fit and a well-defined growth model. It’s crucial to accurately identify the moment your company transitions into a scaleup. Avoid becoming a founder who, despite securing a Series A investment, retains minimal ownership and faces a considerable path to further development.

External factors can sometimes influence fundraising timelines. The valuation of equity in startups is determined by the balance between available capital and investor demand. Investors, in turn, must secure funding from Limited Partners (LPs), who often invest in a diverse range of assets. Increased LP interest in venture capital assets leads to a greater supply of capital and, consequently, higher valuations for startup equity. Conversely, a decrease in LP interest can have the opposite effect. Examining the two most recent U.S. recessions (2000 and 2008) reveals that stock market declines coincided with valuation adjustments within the venture capital landscape.

Therefore, a strategic approach involves raising capital when investor demand for equity is high; otherwise, extend your financial runway and await more favorable conditions. Currently, many startups are delaying their next funding rounds, anticipating a more receptive market in 2021.

2. Location: Tell me where you are and I’ll tell you how much you’ll raise

There are two key factors I observe when startups aim to secure substantial funding: (a) a significant market opportunity capable of supporting a large-scale exit, and (b) the presence of large venture capital funds – as smaller funds don’t require exceptionally large exits to achieve success.

Provided the first requirement is satisfied, where are these substantial VC funds generally situated? They are commonly found in areas geographically close to major markets, and regions demonstrating a history of successful, sizable exits.

However, there’s encouraging news for founders not located in well-established tech centers. Due to the dramatically reduced costs associated with launching a software startup compared to two decades ago, a new generation of companies is emerging that targets these large markets while operating from up-and-coming tech hubs such as Barcelona or Austin. Venture capitalists are recognizing this shift and are increasingly investing in companies located outside of traditional hubs.

Nevertheless, being aware of the size of the venture capital funds within your local tech ecosystem can provide insight into the potential investment amounts from outside funds. It’s likely that, with rapid growth, you will eventually need to seek funding from international investors. The map below illustrates the amount of venture capital investment per capita across global cities between 2015 and 2017.

3. Many fast-growing tech companies never raised venture capital

Paul Kedrosky, an entrepreneur, investor, and senior fellow at the Kauffman Foundation, points out that under 20% of the quickest-growing and most prosperous U.S. businesses received funding from venture capital investors.

Despite the fact that a few startups backed by venture capital have achieved worldwide prominence and pioneered completely new industries, media attention is largely focused on the venture capital landscape. This can create the perception that securing venture funding is a prerequisite for success, as these companies are the ones frequently highlighted in the news. However, this line of reasoning is inaccurate.

We are observing an increasing number of technology companies choosing not to seek venture capital, and a growing trend of startups refraining from publicizing their funding rounds, preferring to operate discreetly. A truly successful and rapidly expanding company is defined by its market leadership and its ability to consistently satisfy its customer base. The method by which a company funds its expansion isn't necessarily indicative of its overall progress or worth.

For founders, obtaining capital to accelerate growth can sometimes involve significant drawbacks, such as reduced ownership, equity dilution, or unfavorable agreement conditions. Consider this insightful look at the percentage of equity founders typically retain when their company reaches the initial public offering stage. Be aware: it generally amounts to approximately 15%, divided among the co-founders.

4. Only raise venture capital if you dare to win (and suffer) big time

Within the venture capital landscape, it’s generally accepted that only 10% to 20% of all startups ultimately generate significant returns; the majority either return only the initial investment or do not succeed. Therefore, founders who accept venture funding are immediately facing considerable challenges. Crucially, your investors will actively push for your venture to be among the select few that achieve exceptional success. Furthermore, your initial team members will anticipate a similar result, having potentially declined other prospects to contribute to your startup.

Essentially, you will encounter intense pressure to achieve rapid expansion and establish market leadership. Don't be misled by the success narratives frequently featured in the media. Constructing a thriving, venture-backed enterprise demands years of relentless effort, rather than a sudden breakthrough, and the founder consistently bears ultimate responsibility. Consequently, pursuing venture capital should only be considered if you are fully prepared to strive for substantial victory and endure significant hardship.

5. Build a personal relationship with an investor

In addition to generating returns for their Limited Partners, an effective Venture Capital firm will support founders in maximizing their potential, ultimately leading to accelerated growth for the startup. A strong VC can provide assistance in numerous ways, such as granting access to an extensive network of customers or potential investors, offering practical guidance regarding crucial aspects of product development and expansion, assisting in the recruitment of key personnel, or providing counsel on global market entry.

However, the most impactful assistance centers on enabling the founder to perform at their peak – and this often relates to their overall perspective. It’s the founders, not the investors, who are responsible for leading the company. An investor’s role can sometimes be simply to offer encouragement and maintain confidence in a founder, even during challenging market conditions. At other times, it involves delivering difficult but necessary feedback or urging the founder to strive for greater achievements. During periods of adversity, having individuals who believe in your vision is crucial until positive outcomes are realized.

As you evaluate potential investors, prioritize those who will cultivate a strong personal connection with you and remain a source of motivation throughout both successes and setbacks.

Understanding the nuances of VCs also involves recognizing whether this funding route aligns with your company’s current stage or if the timing isn’t optimal. However, if you decide to pursue venture capital, it’s important to remember that it represents a significant commitment and requires unwavering dedication to navigate the journey.