Do VCs Really Care If Their Investments Make Money?
Lots of talk and no action is a category entrepreneurs don’t want to be dismissed into. Follow through is everything. Within this uncomfortable financial and employment climate, scores of entrepreneurs have emerged realizing they’re just going to have to do something way better on their own. Armed with an MBA and high-concept, innovative skills, the new business results turn up a lot of fun and sexy startups owned by sales-smooth and deal-closing, well-connected MBAs. These Do-ers know how to get well-funded—courtesy of alumni organizations and the right inner circles populated by VCs and angel investors.
The synergy of big ideas and big money typically turns out a high profile launch with plenty of media coverage and hype. The company rides high in the wake of the often seven-digit investment and all that buzzy hullabaloo, but after a year, maybe two—when it comes down to numbers—it seems that perhaps the company is not really generating their own revenue streams unique to their actual business. The lifeline, the sole revenue stream, is the investor money.
But don’t venture capitalists want to make money on their investments? I spoke with a VC about my observation. After all, should small businesses worry about making money if their real success is just getting someone to finance their latest passion for a year or two, anyway? Turns out I was sort of wrong.
VCs don’t necessarily look for businesses with an already established revenue model
By choosing a revenue model too early, the business locks itself into a model, and it becomes much harder to adapt or evolve if Plan A doesn’t work.
“As a VC, we are shooting for the big outcome, and more often than not this requires several major shifts in a business model for a company over its lifetime,” says David Nevas of Edison Ventures. “If a company locks in too early and starts generating revenue in a way that turns out not to be scalable, it becomes much more difficult to change course later on.
VCs see buzz as marketing they won’t have to pay for
CEOs know the endgame is cash flow. It may seem like they’re just focused on investment dollars, but they are multi-tasking. These are savvy CEOs who are using fundraising buzz not just as a cash-generating event, but as a marketing and recruitment tool.
“Want to get on the radar of the best developers in NYC/Boston/Silicon Valley?” says Nevas. “Or in front of customers who previously thought you were a fly-by-night operation? Or get the industry analyst to finally return your call? You just got meaningful value from your VC investment, and you didn’t have to spend a dime of it.”
Still, while generating buzz helps with investor visibility it doesn’t cement a signed check. It should be used to compliment any other fundraising activities.
Some VCs strive for social currency before monetary currency
A few select times, giving something away for free has resulted in millions of customers and the biggest world-changing companies to date. Yes, Facebook, Twitter, and FourSquare (again)—they acquire traffic and engagement on such a colossal scale that advertisers are game to pay for access to that reach.
“There are a small number of startups that, by targeting a highly valuable demographic, have had companies literally beating down their doors to get access to their users,” says Nevas. “If your business exhibits either of these characteristics, focusing on generating revenue will take your attention away from building the true value in your business. You could have stuck a display ad on the top of Twitter homepage and generated tons of revenue, but it likely would have turned off lots of users in the meantime.”
Understandably, VCs suffer from FOMO (fear of missing out)
Social media has demonstrated the tremendous value of businesses that are built without focusing on revenues until much later in the lifecycle. No one wants to miss out on the next big thing.
“Investors may be tilting their portfolio to invest in more companies at an earlier stage to make sure they don’t miss the future big winners,” says Nevas. “Early stage tech investing is sexy. If you were an early investor in Zynga, every other investment in your fund can return 0 and you still win.”
There’s a lot more competition to make the right (or wrong) investment
There are new angel funds, micro-VCs and other groups that are popping up every week and their singular goal is to invest in tech startups. Most major cities have handfuls of startup incubators.
“Everyone from celebrities to hedge funds want to be a ground floor investor in the next Twitter,” says Nevas. “This flood of new capital needs to get put to work quickly, and is driving the demand for startups through the roof. Entrepreneurs are responding, but it takes time to develop truly innovate businesses. In the short term, we’ll see a lot of derivatives of existing business models or companies without models at all.”
VCs are attracted to passion
If you’ve got a VC interested in your business early on—before much of anything is established—it’s probably because you’re an entrepreneur the VC believes in. Passion, drive, integrity and intelligence are adjectives that top Nevas’ list.
“We need to be confident that even if they don’t get the model right the first or second, or third time, they will figure out a way to make it work, and will be good stewards of our investment,” says Nevas.
VCs love investing in ideas with large target markets. Ideally, the entrepreneur has focused on an already large (think $1Billion+) target market so is growing quickly.
“Smaller or stagnant markets leave less room for error,” says Nevas. “They also provide a larger universe of strategies that ultimately are potential acquirers of the business. We want to know that team understands the industry and opportunity they are pursuing. Sometimes the entrepreneur comes from the industry and has a strong network and deep exposure. Other times, they’ve spent a lot of time researching the space and can demonstrate knowledge of the key business drivers through a detailed financial model.”
Image credit: Tech Cocktail