David Cummings on Startups

4 Reasons to Raise Venture Capital

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David Cummings

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At last night’s Venture Atlanta reception I had the opportunity to talk with a number of entrepreneurs that are out trying to raise venture capital. Naturally, I enjoyed asking the question “why are you raising venture capital?” The common refrain was that their business was doing great and that if an investor saw the potential in it, and bought in at a nice valuation, they’d raise money. Hmm, I thought to myself, that’s not a good answer.

Here are four reasons to raise venture capital:

  1. 5x Exit Value Increase – You’re focused on making a significant amount of money, and believe the company will be worth at least 5x the value compared to what you can build without venture money (the 5x amount comes from expected dilution after several rounds of financing e.g. if you start with 50% of the business you’ll likely end up with 10% at the end of the process, thus needing a significantly greater exit to have a financial gain compared to what you can do on your own)
  2. Winner Take All – It’s a winner take all or most market such that the 2nd or 3rd place company is nearly irrelevant (think about eBay dominating the online auction market in the U.S.), which often requires raising a substantial amount of money and spending it ahead of growth
  3. Anchor Company – You want to build a large, anchor company in your city, as quickly as possible, and need to raise a substantial amount of money for the business to achieve escape velocity so that it can get big quickly
  4. Accountability – You value the accountability that having a board of institutional investors brings to the table on a regular basis helping you to execute at a higher level than you might do otherwise

Other reasons for raising venture capital you might hear include wanting money to do a tuck-in acquisition, taking money off the table (that’s really growth equity or private equity and not traditional venture capital), or to help attract talent. These, along with raising money because of a good valuation, are not ideal as raising venture capital significantly changes the timeline and trajectory of the business.

What else? What are some other reasons to raise venture capital?

Comments

6 responses to “4 Reasons to Raise Venture Capital”

  1. Jennifer Avatar
    Jennifer

    David, good reasons on why a startup should raise venture money.

    Any thoughts on whether SaaS industry esp. CRM, Email Marketing, Marketing Automation or Social Marketing softwares are winner take all markets? Seems like each one has a leader – Salesforce, Constant Contact, HubSpot, Buddy Media/Radian6 etc..but will they capture a majority of the market share?

    Reply
    1. David Cummings Avatar
      David Cummings

      Salesforce.com is definitely in a winner-take-most position but those other vendors don’t have anywhere near a majority position in their respective markets. I don’t believe those industries will be a winner-take-most market.

      Reply
      1. Jennifer Avatar
        Jennifer

        Thanks for replying. I am an avid reader of your blog and love your daily blog posts and insights into the SaaS space.

        What’s so different about CRM vs. the other industries? Are there some form of network effects in play that I am unable to see in the CRM industry that differentiates it from other SaaS markets? Also, what do you think about barrier to entry or long-term play in these markets? Can the existing players be disrupted by new nimbler and more cost-effective startups in the same market? Or do you think for e.g. that Constant Contact (email marketing) is more likely to be disrupted by social (Buddy Media etc.) than somebody who comes up with a better and cheaper product in email marketing space?

      2. David Cummings Avatar
        David Cummings

        Take a look at:

        Why the Proliferation of Successful Email Marketing Companies

        CRM has more network effects with the AppExchange plugins. Other companies like Constant Contact and Buddy Media don’t have the same network effects.

  2. asteinb Avatar
    asteinb

    Tapping into an experienced board, advisors and their networks is a huge reason to raise angel funding, if not venture capital.

    Reply
    1. Tom Blue - Lead411 Avatar
      Tom Blue – Lead411

      100% agree with asteinb. I have bootstrapped my company and I have learned so much on my own, but I would definitely have benefited from an experienced board and advisors.

      Reply

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