AGILEVC My idle thoughts on tech startups

April 1, 2008

My prior post covered some reasons why I believe the VC path may not be right for every technology startup. Here I’ll try to lay out the case in favor of seeking VC funding and what taking VC money means to a startup. A well-respected and very successful VC I know likes to point out that we are ultimately in the business of “selling” expensive money (to get precious equity), but the exchange can be invaluable to both VCs and entrepreneurs.

Capital as an Accelerant
It goes without saying that the primary function we serve as VCs are as providers of capital. But if you look most scenarios facing early stage VCs, we are typically investing in companies where our capital isn’t merely filling an operational financing gap but rather providing an accelerant that lets a startup progress more quickly than it otherwise would. That progress may cover a number of dimensions: recruiting additional members to the management team, going from a prototype to a commercial product, ramping sales & marketing efforts. If the additional of capital can accelerate a company’s trajectory in these ways, then it can certainly be a good opportunity to seek what is ultimately a relatively expensive form of equity financing.

Active Participants in Growth
Most early-stage VCs are fairly involved with their companies. Of course involvement can be both positive and negative… survey 100 different VC-backed entrepreneurs and you’ll inevitably find a number who felt their VC board members were busybodies or tried to micromanage them, and undoubtedly some of this is true. But the most productive relationships between VC investors and startup management teams happen where both parties respect one another and the distinct areas each can add value. VCs can provide strategic guidance at the board level, leverage their personal networks for business development and recruiting, and play a useful role in future financing. We hopefully provide a view across a breadth of companies or markets we’re involved with too, which can be useful to the entrepreneur “in the weeds” of growing his or her business with maniacal focus.

I can tell you that during the early days at LinkedIn, having Mark Kwamme involved on our board and by extension Sequoia Capital played a meaningful role particularly in recruiting. And I hope I’m adding similar value now as a VC to the portfolio companies I’m involved with today.

The Big Pie
The simple math of cap tables is this… if you sell shares to VC investors, you as the entrepreneur are getting diluted in your ownership. Of course dilution is a function of the amount of capital coming in and the pre-money valuation ascribed to the company prior to the round, but suffice it to say that selling a single share = dilution. As I highlighted in the “con” case, you can build a modest sized company without taking outside funding and have a great success as an entrepreneur. But inherent in taking VC funding is generally signing up to the “big pie” plan, as in you will own a smaller piece of the pie due to dilution but the overall scope of the pie will be much bigger in the long run. And for most startups reaching that big pie, whether you’re talking about a $100M exit or a $1B+ exit, is typically impossible or would take an extraordinarily long time without VC funding.

Entrepreneurs who take VC funding aren’t giving up control of their companies (we’re typically not majority owners like buyout firms), but they are trading unilateral control and sole ownership in exchange for both capital and an active strategic voice at the table. If all parties are on the same page the whole can certainly be greater than the sum of the parts.