Early stage companies typically struggle to grow without outside capital – and this scenario exists even after profitability – largely because growth expectations by this point call for making newer investments in people, marketing, and other growth initiatives. These investments are rarely met by organic cash flow and necessitate funding events first from friends and family; and later by institutional venture capital.
Friends and family money is usually obtained fairly quickly and normally, does not involve much choice – in that, founders seek money from people that know them well with the simple goal to ‘just get started’. These well-wishers do add value wherever possible by providing connections and advice, though it tends to be limited in most scenarios – indeed, most founders tell me somewhat wryly, that the greatest value-add is that this money comes in fairly quickly (Read “without much diligence”).
It is the next round – usually a Pre-Series A or an Angel Syndicate round where things get interesting. Startups, at least the more promising ones, have choices on what investors to pursue and in an increasing number of scenarios, whose money to take. Choices typically range from “pure financial investors” – loosely defined as people with tons of investable money but no expertise or deep understanding of the startups core offering – to Venture Capitalists with partners have strong operational backgrounds, investing experience and well-connected to the broader ecosystem.
Savvy startups choose the latter (especially with VCs having a Fund-Accelerator model) even if the process involved more diligence and less startup-friendly terms. This is because institutional capital comes with a lot of benefits that greatly offset any (perceived) disadvantages.
The greatest benefit lies in the ability of these VCs to catalyze organic growth through market access – that is access to corporations that are willing to engage with the investee company for POCs, joint solutions, pure business development deals, or similar growth initiatives. Startups, especially with tech-heavy founders find this – the ability to get the initial few key engagements – as the toughest growth challenge, and by that token the greatest benefit brought by VCs . Initial few customers provide much needed validation, important case studies, and ideally, marketing endorsements that lead to wider adoption, solid beachheads, and springboards for exponential growth. Savvy investors catalyze such activity and provide value from early on.
Aside from market access, value-added capital brings expertise in other areas: defining product roadmaps, making key hires, establishing product-market fit, raising follow-on rounds of funding, refining marketing and pricing strategy, overseas expansion, and lots more – usually by complementing the strengths and pedigree of the founding team. An important study attributable to CB Insights articulated how only 29% percent of startups felt that lack of capital was the primary impediment to growth. The rest felt that business model tuning, creating sales channels, good product design skills sets and a superior marketing strategy were the key catalysts for growth.
This compelling combination of market access, timely advice, and rounding out areas that need to be improved on acts as a great enabler of business growth – above and beyond what could be achieved with plain, raw capital. The value-additions result in many tangible benefits: expedited paths to revenue, shorter hiring cycles, less “hit or miss” bets, better media coverage, increased valuations and opening of numerous doors that would otherwise remain closed. Intangible benefits also accrue: better employee morale, more confidence in sustainability (since institutional investors have dry powder reserved for follow-on financings), and the general gung-ho sentiment that arises from having a true value-added provider of capital by your side.
I constantly advise startups on the need and prudence to choose a smart capital over all other sources of financing. I encourage them choose a partner that is aligned with all aspects of their growth needs and not someone that is being merely opportunistic for short-term gains. The reasons behind this, beyond what has been enumerated above, are fairly obvious: At any stage post-funding, if things turn sour, the “dumb money” will start pointing fingers, press for liquidation events (at least for their own shares), try to foist management changes, and perpetuate other such tactics that are highly detrimental to the company’s prospects.
This thesis is best explained by two somewhat stark examples. In one scenario a VC with deep expertise and connects in the biotech/pharma space made an investment in a bioinformatics company and helped it right from the point it exited an incubator – by helping navigate FDA guidelines, strike conversations with large pharmaceutical players and essentially pave the way for a wonderful multi-100-million dollar exit.
At the other end of the spectrum, a sovereign fund, with little knowledge of the deep tech space made a rash of investments in this industry – thereby artificially inflating valuations, creating immense (and unnatural pressure) on these startups to put to use these large sums of money, and in many cases trying to force corporate decisions that are simply disingenuous for these companies.
Smart Capital tends to retain its true hue even in the most trying time – a hue that exudes, patience, support, and strong alignment with the aspirations of the idea it is supporting.