Who “Needs” Venture Capital?

An interesting e-mail came into my inbox last week from a local technology veteran that most of us know, Basil Peters. He asked the fundamental question of how many technology companies in the past 15 years in BC have actually “needed” venture capital. I believe Basil was being a bit provocative in suggesting that maybe we don’t need venture capital as much as we think we do in this province. But I took his message another way: I looked at what technology companies use venture capital for, as opposed to the question of whether they really needed it at all. Let me explain with a history lesson.

Venture capital came into existence as an asset class in the 1970’s in California. Before that, any start-up company in any industry could only get risk capital from friends, family, personal wealth or individuals looking to invest (yes, angels pre-date venture capital). Later on in the company’s lifecycle, private equity funds were there to invest in minority (less than 50%) or majority/buyout situations. But basically, you grew a company on seed financing and cash flow from sales. In other words, you had to get to sales as fast as you could, which was fine if you were starting a restaurant or a consulting business. Then, out of the aerospace industry slowdown and the garages in Sunnyvale and Mountain View, emerged a different type of company. One that had to spend a small fortune building a prototype, testing it, re-building it and then launching it into a market… all before the first customer receivable. These companies possessed intellectual property and talent that could create a dominant and defensible market position from the very beginning. Smart private equity investors figured this new business model out and gave these inventors in technology enough money to get through the development (burn) cycle in return for shares in their company. Venture capital was born.

The fundamental reason VC emerged was that there was really no alternative to find millions of dollars to get a hardware, biotech or software company started in the 70’s and 80’s. Hardened VCs realized that you would lose more investments than you would win, because the bet was placed before market acceptance. But when you won, you became a large investor in Sun, Apple, Microsoft, Oracle and Cisco… in other words, you made up for all of the losses.

In the 90’s, with the Internet wave (and client server software applications and the networking explosion), venture capital changed. It was still a requirement for those companies that needed $2-20m just to get to the first customer (and much more for biotech), but it also became an accelerant. As more LPs (the limited partners that invest in the VC funds) made money, more of them piled in, giving VCs an embarrassment of dollars to invest. So they morphed to spend all that money by also investing in bootstrapped entrepreneurs and later stage companies (blurring the lines between VC and private equity). When I was a VC in the 90’s and early part of the 00’s, it was a combination of investing in the IP start-ups (investing in the burn) and the “already growing” companies (to accelerate the growth).

Late last decade, the open source, low cost of storage, lean start-up mantra changed the industry once again making it possible to invest very little capital and get companies to grow and flourish. Lately everyone, including Basil, is asking if VC is still needed in this new lower cost world where the burn cycle is much shorter. The rise of the angel investor, angel funds and AngelList have all made it easier to access capital at the earlier stages.

But venture capital is still necessary. There are huge burn cycle companies with protectable IP out there requiring VC under its first, fundamental thesis. VC also can act as the accelerant to companies that need to grow faster. As an entrepreneur (or as an advisor or a mentor), you need to think about the trade of equity for cash and the value that the money brings to accelerate your business. You need smart, hungry, hard-working investors whose whole job is to help create a bigger company. Many angels are passive investors with other jobs who can’t provide the oversight and active help that VCs can and should give.

The good news today is that with more angel money available, an entrepreneur has options. Depending on the size of the capital required to achieve your growth, you may be able to round it up from individuals. But don’t forget that a VC has deeper pockets and is more loyal to an investment over time. Are their companies in BC that “need” venture capital? Yes, Basil there are a few. Are there companies that could use venture capital to grow faster? I would argue that there are many more in that bucket.

(Originally published by Corporate Recruiters)

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