Principle 1: Why Bother With Venture Capital?
Of the top 10 companies by market cap, 8 were funded by venture capital (and they all happen to be founded / HQed in the US). If you look at companies by other metrics such as revenues, or look at a much larger list, the overall principle holds true – venture capital is a very powerful instrument for funding what become large, successful companies.
Principle 2: But Should You Specifically Be Raising Venture Capital?
Venture capital is focused on outsized returns, say 10x in 10 years, and many businesses fitting the bill are in tech. Indeed about half of the capitalization of the Nasdaq, the stock exchange most focused on tech in the US, is from businesses funded by venture capital – Google (Alphabet), Apple, Facebook (Meta) etc. But they represent the 1% of business, in other words 99% of companies don’t raise VC and probably shouldn’t. If you are looking for exponential growth and to get expert help doing so, then venture capital may indeed be the right answer. But otherwise go raise money from many other sources – strategics including corporate, government including grants, family and friends, loans, fund through your own revenues etc. Note both a small-medium business (SMB) and a startup may be risky businesses but the former is looking to grow steadily and be self-reliant versus the latter is looking for hypergrowth and likely unprofitable for a long time.
Principle 3: The World Is Lumpy
Has the Internet flattered the world? Yes in many ways, such that a good company anywhere can theoretically access pools of capital anywhere else. But the reality is the world is lumpy, in that there is a definite concentration of VC dollars. And even within each country the funding is heavily concentrated in a few places. Community does matter, the introduction from someone trusted does matter, and physical location still does matter even if many things can be done much more easily online these days.
Principle 4: VCs Funds Are Icebergs… 90% Is Under The Surface
If a firm says they have $100M what they are saying is they have $100M to invest in the lifetime of the fund, which is typically 10 years. Doesn’t mean they have all this money today. In fact, they typically get these funds slowly as they call the capital from their own investors. Plus they keep reserves to support their existing portfolio. There are also secondaries which means buying shares from others, selling own shares to others, with the company’s consent. Not to mention VC preferences around board seats / observers, information rights, prorata (the option to invest more in the future, keeping their percent ownership), among others. Indeed, how each fund does these things varies immensely and no entrepreneur can possibly know a priori about all their investors. Which is why when talking to a fund, startups can and should absolutely ask these questions and look at diligence as a two-way street.
Principle 5: VC Funding Is Reeling From Over-Correction
Fundraising is always tough but it feels especially tougher right now because of the sudden shift from the exuberance of 2020-22. At Tau our view is that it was more of a correction, not a crash, but that it has been in many places an over-correction before we get back to a stabler point. For instance, the amount of fresh capital raised by emerging managers has declined precipitously in 2023, far below the steady state in 2019-2020. How do we recover? Ultimately more exits (IPOs and M&As) means more investors will have liquidity, which means they will invest in more VC funds, which means funding for startups will also flow better.
Originally published on “Data Driven Investor.” Primary author of this article is Amit Garg. These are purposely short articles focused on practical insights (we call it gl;dr — good length; did read). See here for other such articles. If this article had useful insights for you, comment away and/or give a like on the article and on the Tau Ventures’ LinkedIn page, with due thanks for supporting our work. All opinions expressed here are from the author(s).
