When and Why to Seek Venture Capital: Entrepreneurs and Investors Share Their Insights
By Jack Robertiello
When trying to find the best route to capital for new ventures, entrepreneurs must be specific about their needs and what that support will cost them.
That’s according to panelists at a University of Virginia Darden School of Business Batten Institute for Entrepreneurship and Innovation panel discussion held at the Yale Club in New York City recently — The Venture Capital Startup Funding Myth: Learn How Entrepreneurs Fund Their Ventures.
The panel, moderated by David Touve, director of the W.L. Lyons Brown III i.Lab at UVA, included founders of ventures of various types and sizes, from a charity auction and mobile bidding platform to a technology nonprofit connecting classrooms.
The panelists generally agreed that for early days, bootstrapping (raising operating funds without resorting to angel or venture capitalist investors) was the cleanest way to begin.
Teddy Jones (MBA ’12), co-founder of 501 Auctions, sought little outside funding, forcing him to build the business through profit generation alone. That path was difficult in that nearly any wrong step could mean a catastrophic failure for the enterprise. “Especially if the technology didn’t work, we’d be up a creek without a paddle,” he said.
Jones bootstrapped for five years and has decided that investors bring “headaches as well as good things. While having advisers is certainly valuable, it’s better to not have the pressures of investors clouding your decisions for as long as possible.”
Raising money when bootstrapping often involves what are called “friends, family and fools,” to whom many first-time entrepreneurs turn when they are unable to provide early funding on their own. This casual tier of investors are the most likely to believe in founders with new ventures.
One disadvantage is that this tier is likely to create a scenario with an investor “breathing down your neck,” said Phillipe Sommer, founder of CvilleTrep LLC, an angel investing firm. He is also a former venture capitalist and former head of the i.Lab.
These funders, however, must be aware they could lose their investment. Sommer advised that founders should only raise money from this entry tier if participants pass the Thanksgiving test: If you lose their money, could you comfortably sit with them at the Thanksgiving dinner table? If not, don’t take their money, he said.
Entrepreneurs in the social sector often need to get creative in order to grow a self-sustaining organization, said panelist Monica Gray Logothetis. Logothetis co-founded DreamWakers, a national educational technology nonprofit connecting under-resourced classrooms and real-world careers through free video chat services, with Annie Medaglia (MBA ’15), and the two were classmates as undergraduates at UVA and while earning master’s degrees at the UVA Batten School of Leadership and Public Policy.
“I don’t think DreamWakers would have gotten off the ground were it not for the opportunity Annie and I had to participate the i.Lab in 2014,” Logothetis said. Just three years old, DreamWakers has also benefited from national exposure in outlets such as The New York Times, Forbes and Bloomberg.
Fundraising is also highly integrated with the venture’s core program and long-term growth strategy. “DreamWakers has a unique corporate partnership program that helps companies shine a light on the talent and public service of their star employees, while helping to inspire a generation of young talent to explore a career in their industry,” said Logothetis. Most recently, DreamWakers partnered with JetBlue, who took students in rural Southwest Virginia on a virtual tour of the JetBlue hangar at JFK Airport.
The two biggest challenges in working with corporate partners, Logothetis said, are obtaining unrestricted funds and navigating situations where companies are eager to provide presenters who may not appeal to their student participants, which must be handled delicately.
When it comes to angel investors, they can take their losses very hard and therefore can be difficult, said Sommer. Being in alignment with them on enterprise prospects and goals is key. He suggests performing the same due diligence on investors as they do on entrepreneurial projects, and he recommends selecting angel investors and venture capitalists with expertise in your area.
“Funders must be willing to lose and VC funders are aware of the rate of failure and return possibilities,” said Harald Kruse (MBA ‘07), managing director and partner at venture capital and strategic advisory firm Brand New Matter and CEO of private group transportation booking platform Buster.
Major investors should provide more than simple funding. Kruse says founders should look to them for everything from access to their rolodexes to make needed connections to getting them to promote your company concept.
Founders must be prepared to seek their investors’ input and task them if they expect help, for example, recruiting needed talent or tapping their understanding of technologies that might be useful.
A combination of bootstrapping, angel investing and ultimately $2 million from a venture capital firm combined to help UVA engineering school alumnus Asmau Ahmed build Plum Perfect, a technology startup that analyzes the color of skin, hair, eyes and lips for cosmetic searches. The venture’s funding path also taught the Plum Perfect CEO a valuable lesson.
“It’s essential that startups not seek funding without a viable product,” she said, noting that before raising money, founders need to figure out how to earn a return on every dollar invested, with every move raising the business’ value. If launching today, she would raise money only when the enterprise’s profitability was predictable and says venture capital, which generally allows more room for failure, works best when a company needs to grow larger quickly.
Venture capitalists have a more probabilistic view of the investment world, and with them, deal details are highly defined, said Ahmed. Contracts between founders and investors (called term sheets) can define all aspects of the investment. At one point, Ahmed had two such contracts in hand — one that offered a useful network and compelling board personnel but also what is known as a clawback clause, in which investors exact a penalty if the business misses key metrics.
“A clawback can feel like a poor partnership,” she said
Sommer put it another way, saying that when an investor and a founder disagree on the value of a company, clawbacks are a way of bridging the gap. Founders need to hit agreed upon milestones to justify a high valuation or accept a lower valuation if they miss their targets.
But deprived of the ability to pivot, Ahmed replied, the lifeline of an enterprise is lost. “It is nearly impossible for a founder to predictably know what their business would be doing a year out.”
Either way, Sommer cautioned that startups must employ a lawyer specializing in these sorts of contracts, as the rules change frequently.
Above all, raising money from venture capitalists involves a high level of scrutiny, said Kruse, and any lack of clarity on metrics, growth potential and governance can be damaging. When ready, though, take full advantage.
“Bootstrap as long as you can, but the more voices that are in the room, the better,” he said.
The University of Virginia Darden School of Business delivers the world’s best business education experience to prepare entrepreneurial, global and responsible leaders through its MBA, Ph.D., MSBA and Executive Education programs. Darden’s top-ranked faculty is renowned for teaching excellence and advances practical business knowledge through research. Darden was established in 1955 at the University of Virginia, a top public university founded by Thomas Jefferson in 1819 in Charlottesville, Virginia.
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