Sorry, Not All Startups Should Be Funded

Sorry, Not All Startups Should Be Funded

Surprised at how hard it is to raise funds for your startup or growing business?

Almost every entrepreneur I know who has tried to raise money is surprised by the incredible amount of time, effort and energy needed to raise equity capital. Some actually do raise money for their companies, but most don’t. Lots of “No thanks, I’ll pass” all around.

In the last four months I have spent time with over 100 startup founders and growth company CEOs, mostly in the software business. Several of these have raised major venture capital investment or a smaller seed investment. Many have raised angel or “friends and family” funds. Most are bootstrapping and self-funding their early businesses. There’s no one “right way” to fund a growing business.

Most startups shouldn’t expect to raise equity capital funding

I am a supporter of the expanding wave of new tech startups and entrepreneurial creativity that is happening in Phoenix and in other startup hotspots. Our economic future is rooted in these innovative growers and creative small businesses. Starting a real business is becoming cool, and that’s a good thing.

What’s not good is the expectation from the growing crowd of new startup founders that you simply find an idea, build an early product, get a little revenue and then just “get funding” to grow it into a big business. I hear from frustrated entrepreneurs every week who rail against the difficulty of raising money and how “investors just don’t get it” (both of which can be true).

This should be a lot easier, they tell me. In some cases they are right, but in general, I disagree.

This may not be easy to hear, but the reality is this: For the most part, the startups that aren’t getting funding shouldn’t get funded. And many that get funding shouldn’t have been funded. There are exceptions on either side, but overall I think our messy and imperfect capitalist process is doing a decent job of betting on the potential winners.

It’s supposed to be hard

Even in a boomtime bubble, raising equity capital is not supposed to be easy. Who started the rumor that it was going to be easy and that all savvy entrepreneurs or nascent startups deserve growth funding from outsiders? Remember how the “easy mortgage” game worked out five years ago?

I see fundraising as another test of founders (and their teams) to see how they succeed against the odds. Can they sell to investors – and demonstrate they can sell to customers, employees and partners, too? Can they persevere through difficult challenges – just one of 100 new hard things they will have to figure out as they grow? Can they stay alive without extra cash – by funding their business themselves or by selling to paying customers? Can they get great advice and team members without paying too much?

If you can’t do what it takes to raise money, do you really have what it takes to grow a big business? Maybe not. Every startup founder I know matured measurably with each fundraising experience, as I did.

We need more active seed-level capital in Arizona that is savvy about key sectors like software, biotech and healthcare. We also need more startups in Arizona that have serious potential to grow up and have successful exits. There just aren’t enough of those yet either. Despite these challenges, I still see sturdy startups regularly getting funded here in the $500K to $2 million range every month. For every one of those, there are dozens that don’t get funded. I’m OK with that.

Angel and VC investment doesn’t pay off most of the time

Along with the explosion in startups, there are are more early stage investor options then ever: more seed stage funds, more incubators, more organized angel groups and new equity crowdfunding options.

This doesn’t mean these investors are rolling in capital and are eager to fund every speculative investment. Investors face long odds too (even before the recent stock market downturn). Even after the tortured investment screening process and in-depth due diligence, most funded companies fail outright or don’t grow into more valuable businesses.

The current reality is most VC funds and the majority of angels are not getting paid back positively on their overall investment portfolio. A few big winners for a few VC funds mask the overall challenge that most investments don’t pay off and average VC returns on their capital are not exciting. Angel investments are also taking longer to exit these days, which means early stage investors won’t get a return on an investment for 7-10 years, if at all.

The seed-level venture capitalists I know talk to dozens of high potential startups to find the few into which to invest their scarce funds. This means they say no to most of the founders who knock on their door. From their perspective, it’s really hard to win at this game and they want to bet on the most likely to succeed. Entrepreneurs should understand they are competing for capital against all the other high potential startups that angels or VCs evaluate. Do you have really a top 1% deal in their eyes?

Ready to play the game?

When a founder sells a major piece of ownership in her company to raise money to grow, she is committing to work as hard as she can to successfully grow the value of company and eventually sell it (acquisition or IPO) to pay back the investors. Good or bad, that’s the game you sign up for when you raise money.

It’s game on, and most pre-funded startup founders just aren’t ready to confidently play that game yet. Others are ready, and they demonstrate their readiness when they raise money.

Entrepreneurs should choose to play this game wisely, if at all, knowing that it will be hard and the odds are stacked against you.

I have been in the funded startup-growth game for 25 years and I know it can be exciting, frustrating, harrowing and rewarding. It’s not for everyone. I chose to play it. Thankfully, it’s not the only way to grow a successful business.

That’s what I think. What do you think?