Why You Should Say No
Several weeks ago, Keith Gillard posted a blog entitled Why We Say No. The goal of that post was to help those exploring venture capital financing to clearly understand the partner qualities we typically look for before walking down the aisle. Hopefully aspiring advanced materials entrepreneurs with the most promising ideas will take this constructively as they build their companies to the stage where Pangaea can say yes. Today however is about the other side of the story and the common situations where my advice would be for the entrepreneur to say no. I am not talking about saying no to an investor that is a poor fit or who has offered unacceptable terms, but rather saying yes to the single life free of VCs all together, at least for now. Let’s look at three valid reasons:
- The Clock Speeds Up
I hear from entrepreneurs all the time who are under the illusion that everything would just fall into place if they could just raise their round of venture capital. Money solves many problems and venture capital is the perhaps the best instrument to build the world-class technology team and infrastructure required to accelerate development progress as quickly as possible. The problems arise when the nature of the technical problems that are being solved or the commercial barriers that need to be overcome make it unlikely that value inflection milestones can be met within the plus or minus two year period that a typical venture round will last. Sophisticated VC investors understand that bumps and forks along the road are a fact of life, but if you are chugging along without a gas station or final destination in sight, investors can quickly lose interest. With a ramped up burn rate and other possible liabilities, the flexibility to pursue a different path can be reduced. A better approach is to grow slowly and flexibly in the early days so that when VC funding is raised, the proverbial hockey stick really is three to five years away.
- Betting on One Horse
Venture capital funding is typically provided to allow for start-ups to make rapid progress on milestones that build to create the best-in-world company addressing a major pain point in the market with the most attractive combination of size, growth rate and industry structure. Interim or first generation products are often the logical singles along the path to the grand slam homerun but rarely is a round of venture funding provided to target the laundry list of opportunities that may be possible. The problem is heightened for advanced materials start-ups where platform technologies are the norm. The temptation to meddle in all of these may be seen as a way to hedge risk, work on lots of interesting projects and survive on a multitude of government grants and engineering service revenues. This is a valid and sensible approach in the early days but a VC injection usually means making a bet on a specific market opportunity. Sure there will be pivots along the way but getting the market completely wrong from start is usually the kiss of death. VC funding should correspond to a stage where there is an educated market guess, rather than still trying to see what sticks.
- You Now Have a Boss
Many people follow the entrepreneurial path seeking to free themselves of the bureaucracy and hierarchy of the corporate world and pursue the dream of “being their own boss”. Often, the closing of a venture-financing round marks an overnight transformation of the corporate governance of an early stage firm. Suddenly a board of directors is formed to play many roles including the role de facto “boss”. While most boards shy away from micromanagement and meddling into operational issues, the accountability of a management team in a VC backed environment usually far exceeds that found in the corporate world. If execution is not world-class or if new skills are required, it is the board’s responsibility to ensure the required management team is in place. While VCs like Pangaea are betting that a founding team has what it takes to take a company from soup to nuts, often with some help along the way, if performance is falling short, founders must realize that the board has a fiduciary duty to all equity holders to supplement or even change the team that is in place. If even a slim possibility of essentially being “fired” from “your” company doesn’t sit well, then VC financing might not be for you.
There are numerous other considerations but above all it is best to recognize VC as an asset class developed for a specific risk-reward subset of early stage corporate growth. Just as we take the time to select the investment opportunities where we can deliver value to all of our stakeholders, it only makes sense for the entrepreneur to closely consider whether venture capital is the right funding model for the company and its stakeholders. If your technology, market opportunity and business plan fit, then VC fundraising is the easy part compared to world-class execution. If not, we are still interested in hearing from you and will usually have feedback on different financing options or the changes and progress needed to become a better fit.