Grow Revenue Before You Seek VC Funding

- Russell Rothstein is the founder and CEO of business social networking site SalesSpider. The views expressed are his own. -

Small businesses owners want to grow their companies, but their ability to expand operations is limited by their own profitability or otherwise lack of capital.

Faced with this dilemma, many turn to venture capital firms (VCs), which embrace high-risk, high-growth startups and offer the money and management they desperately need to meet the growing demand for their product.

Money may not make the world go 'round, but it certainly helps when financing a high-growth new business venture. And there are no shortage of VCs to turn to. But while many small businesses rely on VC funding, few CEOs really think about the strings attached to all that cash, and what it means to their company and customers.

VC funding may appear less desirable in comparison with revenue-based funding, for example. Consider the differences between the two:

1. VCs dilute the startup's equity every time they invest and want board representation. Clients, aka revenue, don't want equity; they want results.

2. VCs want a certain level of control over a startup's financing. Clients want control over their financing.

3. If VCs invest more than once (e.g., at Stage 1 and Stage 2), they start to dilute the founders and early stakeholders to a point that they no longer own the company. Clients who buy more than once are satisfied -- and become key references for gaining new clients.

4. VCs are convinced the only measure of success is a very large exit. Clients believe success is finding a supplier that helps them solve a problem. They may want a startup to be successful, but not necessarily very large.

5. The more VCs you get, the harder it is to attract VCs. The more clients you get, the easier it is to attract other clients.

6. VCs don't really help you get clients, unless they own the client. The more clients you get, the easier it is to get VCs.

7. Sometimes you need VCs, but you always need clients.

8. Clients are afraid of you flipping your company. VCs insist on it.

9. Banks often lend money based on client receivables with low rates of interest. VCs have clauses where they lend you money, but it's usually convertible to equity.

10. You can usually keep most clients happy if you provide good service. VCs tend to always want more.

Certainly, VCs play an important role in maintaining a vibrant economy and fostering the entrepreneurial spirit, but VC funding is not the right choice for every startup at every financing stage.

Weigh your options before turning to a VC, and determine the level of involvement clients play in supporting your company and its future.

Copyright 2010 Thomson Reuters. Click for Restrictions.

Comments

[Sundialsvc4]

06:41 AM on 12/29/2010

During the 1990's, the notion was made very popular that your actual "business" consisted merely of "getting to the Next Round(TM)." You would then reach Nirvana: you would "Go Public(TM)," and then retire filthy-rich at the age of 21 to spend the rest of your happy days playing golf and eating bon-bons.

It never worked out that way, even during those times, and it never will.

A venture capitalist is a very specialized form of investor, but certainly not a fool. If they determine that what your crop needs in order to grow is a tanker-truck load of fresh water, they can provide it. (They can even build a pipeline to your fields, if necessary.) A venture capitalist looks for parched but promising fields that need water, and sells that water (effectively) on credit. The VC might be willing to accept the non-zero possibility that the field will just turn into a mud-puddle and not produce a single crop, but you can be damn sure that he's already calculated that risk to be as close to zero as he can possibly make it.

VC's might sell water (or a pipeline) to a farmer, but they will never deign to become farmers themselves. Their product, as it were, is money. Which is a perfectly legitimate and necessary product. But when the time comes, do expect to sell the farm.

[guveqzero]

03:05 PM on 12/28/2010

Yes, my experience with US VCs is that they think like most Wall Street traders. They are looking for the easy money to turn their investment into a series of quick transactions. These do not create local jobs, nor do they create new industries in our local economy. This is capitalism gone wrong. Politicians relying on these investment bankers to turn our economy are going to be disappointed.

[ResearchtheFacts]

07:49 PM on 12/27/2010

I love this one...8. Clients are afraid of you flipping your company. VCs insist on it.  Assuming you want to run it long term.  One Canadian company was broke for the three years of its existence before being bought out for millions.  How is flipping your company necessarily bad?  We live in a fast food society.  Who thinks about tenures these days?

As an intellectual property lawyer once told me... If you can come up with one good idea you are capable of coming up with many.  No set rules, just play the game and play to win.

[Sundialsvc4]

06:51 AM on 12/29/2010

Bear in mind also that when the company "is bought out for millions," the venture investors own the preferred debt. They get paid-off first, recouping both the money that they invested and a sometimes-tidy profit. The original owners (and other shareholders) get what is left, if there IS anything left. In quite a number of cases, there really isn't anything left.

When someone (who is in the IP-law business) speaks of "playing a game to 'win,'" I find myself pondering the story of the Sower and the Seeds, in the Gospel of Mark. I wonder exactly what is the "game" that they are playing, and exactly what it means to them to "win" that game.

An intellectual-property lawyer, for instance, "wins" whenever he can talk you into "playing the game." He has no personal stake in whether you win or whether you lose; only that you continue to play. Simple statistics tell you that he, the lawyer, has two clear ways to "win" the game that HE is playing: (1) by striking it rich; or (2) by selling mining-supplies to "people like you" who never will.

History tells us plainly that it was the hardware-store proprietors ... people like Leland Stanford, for instance ... who made the most money from the Gold Rush. Peddlers of shovels, food and photographs.

[ResearchtheFacts]

02:29 PM on 12/29/2010

Some really good points, but it all depends on the nature of that business.  Let's take a creative business for instance.  Creative entities just want to create.  Consistency is the key. Output, output and more output.  When they sell a business they are not necessarily selling their talent but their talents for the period of time they produced under that label.

Also, some digital content creators are making more than AMD a hardware maker.  You can look at the coin from many different angles. You made some good points, though. Every company is different with different objectives.  One size does not fit all.  This may be good news for some and bad for others.  To each their own.