Venture capitalists sell money. Their job is to sell their money to very high growth businesses in return for an equity stake in that business. This is a simplifi­cation of the venture capital dynamic, but the critical aspect is investing in the right businesses. If they don’t do that, they won’t manage successful funds.

Venture capital is only suitable for a small number of people and businesses. Historically the industry has done a poor job of communicating how it works and what businesses it is right for. There are lots of very good, productive businesses that just aren’t right for venture capital investment.

Raising venture capital for one of these businesses will be difficult and time-consuming, if it can be done at all. The relationship between the company and the investor after investment is likely to be even more difficult. At heart, because the relationship will be based on a misunderstanding.

What is Venture Capital designed for?

Venture capital is designed to invest in a very small proportion of businesses that have a realistic chance of growing very quickly (an absolute minimum of 50% p.a.) for a sustained period of time (at least 5 years).

This means that small businesses can very quickly become big businesses and the value of the shares in the company will increase many times over.

Venture capitalists focus on extreme upside outcomes as we discussed earlier.

Understanding ahead of time which businesses will be able to perform at this level isn’t possible. Venture capitalists believe that by carefully selecting companies, they can improve the odds of companies in their portfolio performing at this level - but nothing more.

So, venture capitalists are focused on driving extremely rapid growth for a sustained period. If you are also committed to going for extremely rapid growth then it’s likely to be a good ­fit, otherwise you need to think twice.

Inevitably it is when there are problems, and all businesses face difficult periods, that a misalignment of objectives really shows up. A classic example would be – a business is growing ‘nicely’ (say 25% p.a.) and therefore the founder is not too unhappy with performance and the direction of travel but is surprised to learn this doesn’t work for venture capitalists' commercial model.

In that situation, they would rather take a big risk in the hopes of turning the company into one that is growing really fast (>50% p.a.) even if doing so risks bankruptcy. If the management team feels otherwise because they don’t want to risk their business there is obviously going to be a conflict

This isn’t anyone’s fault. The issue lies in the two sides not understanding each other’s commercial drivers upfront.

Venture Capital: The right for your business?

Venture capital is not the panacea that many entrepreneurs think it is. There is a whole industry designed to preach the virtues of venture capital. Media companies, lawyers, accountants, corporate fi­nance advisers all make money from the venture capital industry. There are lots of people with an interest in entrepreneurs raising venture capital.

Not surprisingly given this backdrop many entrepreneurs believe that raising venture capital is key and tend to focus on it as an end in itself. The truth is that it is a tool (a very important one!) for an entrepreneur to use when building their business and nothing more.

As with all tools it should only be used for the job that it’s designed for. It’s not useful in all situations.

Many people left disgruntled with venture capital have simply misunderstood its purpose. They have tried to use the wrong tool for the job with predictable results. Venture capital is appropriate for a small number of businesses, so before you try to raise it you should think clearly and honestly about your motivation and your business.

If it is appropriate then go for it, it is more likely to help you than hinder you.

If it isn’t appropriate, then you’re probably on a road to frustration and possibly worse. Even if you can raise venture capital it’s likely that the mismatch will become clear, at which point you’re likely to have a problem on your hands.

Top Tip: Venture capital is right for your business if you are solving a big problem, have a sustainable advantage and the team to build the solution and scale quickly.

If you can honestly answer the following questions with an affirmative yes! - then you are an appropriate business for venture capital investors:

1. Are you (and your management team) really committed to building a big business?

   This isn’t a case of saying you’d like to. You need to commit to this accepting the pressure, late nights and difficult decisions that it will require.

2. Can Your Business Grow Really Quickly?

   Growth is the venture capital industry’s raison d’etre. If you don’t believe that your business can grow at over 50% p.a. for the foreseeable future - it’s probably not a good ­t for you.

3. Does Your Business Have a True Sustainable Advantage?

   Some people see this as a requirement to answer ‘Yes’ to question 2. It is worth looking at separately to be sure that you are clear on this. Where does your business have a true sustainable advantage? Does it truly have one?

Again, if so, your business would be a good ­t for venture capital. If you don’t have a sustainable advantage, you should probably think carefully before raising venture capital. And, if you decide that it is right, will make the fundraising process far simpler.

If your business requires further advice on any fundraising advice, please book a discovery call below with one of our business advisor at Dragon Argent.

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