Since I’ve gone through the process of raising venture capital a few times I often get asked how it works and what it’s like.  I thought I’d share some learnings, based on my experiences. I’m not an expert by any means, but I’ve done it a couple of times so I am not a total newbie. Here are a few thoughts I have:

1. Before trying to raise venture capital, decide what you want your business to become. Think out 3-5 years and figure out what ideally would your business look like in terms of size (revenues and people) and what business are you in.  If you are not sure about wanting to build a large business then do not raise venture capital.  If you are concerned giving other people a lot of say in your business do not raise venture capital.  If you never want to sell your company or go public do not raise venture capital.  If you would like to build at least a $20M business over 3-5 years and ideally a $100M+ business over 5-7 years you are a prime candidate for venture capital.  If you want to build a $3M business over the next 5 years do not raise venture capital. 

Venture capitalists are in the business of giving entrepreneurs money and then eventually getting some multiple of that return back.  They do that by investing in people they think can build big businesses, by investing in concepts that they think can be big businesses, and then eventually turning their equity stake into cold hard cash.  Venture capitalists get their money from investors and they have to return a lot more back to their investors some years after taking the money.  These are the things that motivate venture capitalists.  If you are doing something that is not in line with this then working with venture capitalists will be very painful.

Having venture capitalist invest in your company means you are signing on to be a high growth company and will do the things necessary to grow quickly and build the talent base, processes, and infrastructure that is necessary to support a high growth business.  This is great if the business is doing well; if the business runs into tough times and you are not profitable but rather investing in your company this can cause the company to run off a cliff (i.e., run out of money) or you to lose control of your company.   Just something to think about…

2. It takes a lot of time to raise venture capital.  Let me restate that in a more emphatic fashion: it takes a crapload of time to raise venture capital.  I started my first company when I was 19.  It was an e-commerce company called Chipshot.  When I graduated from college at age 22 I went to raise venture capital.  As you can imagine most venture capitalists wanted nothing to do with a 22-year old (this doesn’t make that much sense to me since all the biggest hits ever have come from folks in their 20s, maybe another post on that later, I guess too many failures of folks in their 20s).  Anyways, I digress.  Back to the subject… I did have a running business doing $100k a month, and for 1998 that was quite a bit of business to be doing online, so venture capitalists were interested.  Turning that interest into funding took 4 months of almost full-time work.  I basically spent 15 hours a day on phone, email and in meetings selling the heck out of my company and our team.  Then once you find some folks who are interested, you have to figure out if how they value your company is how you value your company and if then negotiate the deal.  Trust me, with term sheets, lawyers, negotiations, strategizing, and, oh yeah, you wanted to spend some time on your business, right? — it is brutal.  We were lucky to get through this process, not kill our business (thanks to some great guys on our team), and find some great partners in Sequoia Capital who invested $3M in our business in September of 1998. 

I find lots of people who seem to get really excited by the prospect of raising venture capital.  Don’t be.  It’s overrated.  It takes a lot of time and takes you away from your main aim – which is building your business.  Venture capitalists, for the most part, are decent people who are investors.  Some are very smart and people who I love to interact with, some I wonder what value they add.  There is nothing special about them as a whole.  And raising venture capital, while a nice milestone for your business, does not make your business a success.  It, in fact, raises the bar higher on the success you have to achieve.  The goal of your business is not to raise venture capital (well maybe it is, but I don’t think it should be).  The goal of your business is probably to have lots of happy customers and employees and make truckloads of profits (maybe in a different order).  Don’t forget that – the sexiness of a press release saying you raised venture capital from XYZ and ABC lasts about 1 day.

3. Most venture capitalists are paid not to be innovative dreamers, but rather data driven.   How many times have you seen a venture capitalist do something innovative, something that really changes the VC business?  Recently, Charles River Ventures started the CRV QuickStart program.  I was impressed by this – a VC actually shipped a product that dealt with the changing nature of the venture business and did it in a very advantageous way to them and to entrepreneurs.  Impressive.  But these examples are few and far between. 

VCs are not in the business of coming up with crazy ideas and then throwing them against the wall and seeing if they stick.  That is the job of entrepreneurs.  That’s why most VCs will be loathe to invest in some “idea” you have that will change the world that nobody has ever done before.  If you can’t give them any proof points of people using your product, or some initial demonstrations of the technology, or some customers who say “if you build this I will buy it” they will push you to get to this stage before they invest.  For VCs, it’s all about risk and reward. Bill Gurley, a partner at Benchmark Capital, talks about wanting to invest in social networking companies after they’ve taken off, as it’s really hard before the fact to figure out which ones will be successful.  About a year ago I had a VC at a top firm tell me that they prefer to invest in Series B deals over Series A in India because they find that valuations haven’t gone up that much (maybe 50%), but the business has had the chance to evolve a lot more and is derisked (if that’s a word).  Way lower risk, almost the same reward. 

4. Venture capital is expensive, and there are many other forms of investment available.Venture capital is a very expensive form of investment for your company.  If you are the typical early stage startup you are going to give 20-35% of your startup for $1-4 million of investment.  If you were instead to raise $2M of debt you might pay a 10-15% interest rate, so each year of debt would cost you $200-300k in interest payments.  That is a lot cheaper than selling 20-35% of your company.  The catch, of course, is that for a high risk venture that has a good chance of flaming out it will probably be difficult/impossible to raise debt unless you have an amazing track record of building companies before (if you have an amazing track record you probably wouldn’t be reading this posting). 

Friends and family and angel investors are another route.  It is harder to raise large amounts of money from these groups, but if you just need a $100k or $500k to get to some milestones friends and family and angel investors might be easier to work with and you will sell less of your company in aggregate. 

Of course, there is also investing your own money.  I started my current company Komli by investing my own money.  I felt this aligned me with all my investors and showed my commitment, I also wanted to bet on myself.  Investing your own money is more of a personal choice as you are also investing your own time and energy and may be getting a lower salary at your startup than you did in the corporate world (which is your opportunity cost).  I also once had a good friend tell me that if you work in the corporate world don’t get your life built around making some huge salary.  Manage your life so you can live on some relatively decent money (he said $75-100k in the US), and then just save the rest.  This way when you start something you can invest your own money to get it going, and having to go from some high salary to some lower salary (like $50k or $12k for a while) won’t be an impossibility.  If think is decent advice; it’s not easy for most people to follow though. 

5. The right venture capital partner can be very valuable to you as an entrepreneur.   After hopefully giving you some nibblets to chew on and think about before rushing into venture capital, I will say that the right venture investors can be HUGELY helpful to building your business.  I have been lucky enough to work with a number of venture capitalists in my career and so far I haven’t had any bad experiences with the folks who have invested in my company.  I have been lucky enough to have only good experiences.  It’s a little bit like a marriage so choose your partner carefully; it’s pretty hard to get your venture capitalists out of your company if you decide later that you don’t like them.  Venture capitalists can generally bring you one or more of the following things: 1) strategic understanding of the market, 2) technical knowledge of the market and how to build a better product, and 3) relationships/Rolodex, and 4) venture capital wisdom (this is the catchall category that represents the wisdom many venture capitalists have after having played the game a hundred times before your company).  Think about what you want out of your venture capitalists — what things are you weak at and what do you need help with.  Just like having the right employee makes your life so much better having the right venture investor helps you think through a lot of issues, provides a sounding board, and knows enough people to ask for a second opinion when you want a second opinion. 

Okay, those are my thoughts.  I hope it helps.  Look forward to any comments.