While eye-poppingly large rounds of venture capital can raise the profile of a startup as it emerges into a fully fledged player in its industry, two venture capital fund leaders say it isn’t always the best way for entrepreneurs to get financing.
The session at Boulder Startup Week featured Matchstick Ventures partner Natty Zola and Brett Jackson, managing partner at San Francisco-based V1.VC.
Why VC isn’t always great
Because venture funds are often raising money for their own investors, they have an incentive to encourage rapid and aggressive business scaling to collect high returns to cover potential losses from other portfolio companies folding.
“VCs tend to make, I don’t know that they’re necessarily more risky bets per se, but tend to want to make (and) build a portfolio of investments to diversify within their fund, knowing that about a third of their companies will fail, a third might return their capital, and then a third will drive the returns for the fund,” Zola said.
Venture capital also tends to be dilutive, meaning that startup owners have less control over their companies and reap less of a reward if they sell it off. Jackson said his group usually expects to have their initial investments in a company to become diluted by at least half by the time they exit their positions, and the founders are also getting diluted over time as they take on more funding.
Friends, family and angels
Two primary ways to get early funding without divulging equity in a startup is through either a “friends and family” round where loved ones can buy in at small amounts, or through angel investors that are familiar with venture capital but use their own money instead of investor dollars.
Going to loved ones to get funding is an option when an entrepreneur is just starting to flesh out an idea, Jackson said, but he warned that it’s important to make sure that they know they could fully lose their investment if they decide to offer some early funding.
“Set the tone from the beginning that it’s gonna be a long, hard journey, and you want their support along the way,” he said. “But if things don’t work out, you want to still be cordial with them.”
Angel investors can require the same due diligence and oversight that a traditional VC firm would, but working with an individual who shares a passion for the industry the startup is in could allow an opportunity for mentorship and pitch development before a company reaches the point where it needs to start asking for large sums of capital.
Zola said some early-stage companies may be able to find the right angel investor by asking a venture-capital firm for advice because those firms often have people investing on the side, but cautioned that it may require some management to get an angel investor to understand why a startup is coming to them directly instead of getting funded through a VC fund.
Funding can also come from startup accelerators, ranging from small and focused firms to blue-chip groups such as Techstars in Boulder, which Zola used to manage.
While some accelerators will require startups to give up equity in exchange for a relatively small amount of funding, Jackson said a good accelerator will provide enough mentorship and connections to lead to other funding opportunities down the line.
“It’s just incredible to see how many companies that have gone through Techstars that have tremendously benefited not only just the three-month period, but like I said, the network,” he said. “You’re then kind of ingrained in the network of these accelerators.”
Certain startups that are spun out of universities can qualify for institutional grants, while others that focus on defense or products of note to public-sector agencies could compete for research grants funded by federal or state governments.
Jackson said while those grants aren’t likely to produce as much funding as a venture-capital round, it provides a double benefit to a startup. He’s seen that in AVX Aircraft Co., a Texas company that he worked at before he co-founded his VC firm in 2014.
“I think it’s a very good way… to build early credibility with customers that are validating your product or service, and that can lead to other types of financing,” he said.
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