Business takes money. Money is either earned or invested.
With start-ups, the focus is on investments. Investments are made by those who have funds and a risk appetite for start-ups.
This does not always mean venture capital. Although venture capital can accelerate growth faster, in many cases, venture capital is either not needed or not helpful.
We often get questions about how and when a start-up should seek venture capital. While generalizations are hard to make and even harder to apply, they can help you think about your start-up and how to fund it. Here is what we typically recommend for start-up clients.
Start With a Small Capital Raise
As a start-up is looking for its market fit, we often advise the entrepreneur to raise a small capital raise. These small first-round investments usually come from the entrepreneur, their family or friends, or an angel investor.
These funds should be used to build a minimally viable product, sign up initial customers, and assemble the first team members.
Consider a Small Second Capital Raise
If the business learning accumulates and the product passes initial market testing, it can help to have a second capital raise.
This may come from a bank loan or another angel round.
The funds should be used to take all of the steps needed to show that you have a scalable business.
The One Year Assessment
The first and second rounds are usually done in the first year. By this time, you should have enough data to project how the revenues compare to expenses.
The question is whether in the next three years the business’ revenues will allow it to break even, whether you can take the revenues from the $1 million to $3 million mark during this time, and whether you can go from $3 million to $8 million by year five. These numbers are just examples to illustrate the point. If you can meet numbers like this, the business may be able to grow without needing venture capital.
This is a great position to be in. It means that you can scale the business and buy time to see if you can get an even bigger venture capital round in the future if the business reaches that level. If it does not, the business can stay a small to medium-sized business that produces great profits for the investors and, if you are a true entrepreneur, for you at your exit.
If the data shows that you can generate substantial revenues by adding venture capital funds, say $40 million in revenue or more in five years, you should consider a venture capital raise. This is also a great position to be in. Having at least a year’s worth of data that demonstrates market fit combined with a functioning product that is attracting clients and is scalable, is an easy venture capital pitch.