Beyond Venture Capital
There has been a lot written lately about the shrinking of the venture capital market. Here are some stats from recent posts across the web:
Some of this is cyclical. VCs usually only raise a new fund once every 3-5 years. So, one slow quarter or even a slow 3 quarters doesn't foretell the end of venture capital. But, it's clear that the VC business is shrinking in several ways:
- LPs (limited partners or investors in venture capital funds) are commiting less money to the venture capital sector. This means that there will be fewer funds and those funds will be smaller than before.
- LPs are getting tougher on the terms that they pay to VCs, particularly on larger funds. This is affecting the fixed management fees, which pay VC office rents and salaries, and the carried interest (share of the upside of the investments), which is how VCs used to make most of their income. LPs don't want VCs making big salaries off the management fee and want some level of return for themselves before sharing with the VC.
- VCs are slowing down their investment to push out their fund raising into the future when, hopefully, things will be better. Also, some LPs are asking their venture capital funds to slow down their investment as the LPs are short of cash from liquid investments to use to make their capital commitments to the venture funds. Even multi-billion dollar endowments can have a cash crunch!
- The old guard VCs are having an easier time raising money than upstarts. Much of the money being raised is by brand name funds or brand name investors. Innovative new funds are getting pushed aside due to the cash crunch at the LPs. And, poor performing funds will struggle to raise money.
- Due to the slow exit environment, more companies are having to fund their growth internally or with their existing investors. As those investors old funds start to run dry, it will become difficult for even good companies to get access to the cash they need to grow. Some will sub-optimize their growth and others will be forced to sell before they would otherwise want to.
What does this mean to an entrepreneur?
- You need to get your company to revenue faster and close to cash break-even faster. VCs are still going to be needed to get companies off of the ground, but it could be tougher to count on them for expansion stage capital. Of course, there are still other ways to get a company off the ground -- bootstrapping it, angel financing, etc.
- Choose your syndicate carefully. VCs who are unable to raise a new fund will slowly whither away. The lack of sufficient new capital to invest and the associated management fees will cause partners to leave. Old investments in old funds get put into caretaker mode and will have trouble squeezing new capital out of the investors. Make sure your investors are healthy and have a long runway.
- Look for other sources of capital as you get closer to break-even. If you have revenues and hard assets, you can consider debt to fund your business rather than equity. Don't over-leverage your business, but a modest amount of debt in a growing company is a good thing as it preserves the existing equity structure and is a source that can be tapped again as the debt is repaid. However, too much debt or debt in a non-growth company can be a killer. You need growth to repay the debt or the debt service will crowd out your operating expenses.
- Don't count on your investors or board to solve this for you. They can be helpful, but the company's leadership needs to ensure that the company is financed, in partnership with the investor base.
Overall, I think that the start-up financing arena will be a place for innovation. There will still be plenty of venture capital for the best ideas and teams, but entrepreneurs will also be challenged to get their companies going without venture capital or plentiful late stage financing. One of the keys to success is keeping your company financed, and those who do so have a big advantage.