before going up Money As a cash-strapped fledgling startup, it can feel like all the problems you’re experiencing would go away if you just had some money in the bank. On TechCrunch, it often seems like every other startup story is about another fun company raising portfolios full of venture capital.
Millions, billions, of dollars are flowing into tech startups of all kinds, and as the de facto news hub for the startup ecosystem, we’re as guilty as anyone of being a bit on the “cult of capital” side. “. . One truth is that successfully raising capital from a venture capital firm is a huge milestone in the life of a startup. Another truth is that VC is not suitable for all companies. In fact, there are significant downsides to raising money from venture capitalists. In this piece, I am taking a look at both sides of the coin.
I have two day jobs. One is as a pitch coach for startups, and the other is as a reporter here at TechCrunch, which includes writing our fantastically popular Pitch Deck Teardown series. Before these two-day jobs, he was the portfolio manager at Bolt, a hardware-focused venture capital fund. Unsurprisingly, that means I talk to a lot of early-stage companies and have seen more pitches than any human being should.
However, many of the pitch decks I see make me wonder if the founders have really thought about what they’re doing. Yes, it’s sexy to have a lot of cash, but money comes with a catch, and once you’re on the VC-powered treadmill, you can’t easily step back. The corollary to that is that I suspect a lot of founders don’t really know how venture capital works. That’s a problem for several reasons. As a startup founder, you would never dream of selling a product to a customer you don’t really understand. Not understanding why your venture capital partner might be interested in investing in you is dangerous.
So let’s take a look at how it all fits together!
Where venture capitalists get their money
To really understand what happens when you raise venture capital, you’ll need to understand what drives venture capitalists. Simply put, venture capital is a high-risk asset class that money managers can choose to invest in.
These fund managers, when they invest in venture capital funds, are known as limited partners or LPs. They sit on top of giant mounds of cash from, say, pension funds, college endowments, or the deep coffers of a corporation. Your job is to make sure the giant pile of cash grows. At the low end, you need to grow in line with inflation; if it doesn’t, inflation means that the purchasing power of that capital pool is shrinking. That means a few things: The organization that owns the cash is losing money, and the fund manager will likely be fired.
So the lower end of the range is “increasing stack size by 9% per year” to keep up with the current rate of inflation in the US Fund managers typically beat inflation investing in relatively low-risk asset classes, a strategy that works best in low-inflation environments. Some of this low-risk investment may go to banks, some will go to bonds, while some will go to index funds and trackers that keep pace with the stock market. A relatively small slice of the pie will go to “high-risk investments.” These are investments the fund can “afford” to lose, but the hope is that the high-risk/high-reward approach means this portion will double, triple or more.