Venture capital aka VC is optimized for exponential growth – it is an incredible fuel for your engine but it is also definitely not the right choice for all situations. In fact, even if you are an entrepreneur optimizing for VC, there are many reasons to not focus the current fundraising on that type of capital. Some key reasons include:
- traction: Not enough traction just yet to bring on new venture investors
- terms: Not getting the terms you are expecting
- timing: You want to close the round in a timeframe different than what most VCs would do
This article will discuss the pros and cons of major options available to most startups. It is purposely not talking about crowdfunding and ICOs, which are typically more specific to certain types of companies, and larger topics in of themselves in terms of potential and pitfalls.
1) Angels – If you are looking to raise just a little bit of capital, especially in between rounds, going to angels with a SAFE may be the most efficient way. SAFE is a well understood structure so removes legal costs and optimizes for speed. Three standard techniques:
i) Have a cap that is acceptable to all relevant parties namely you, existing investors if any, and prospective investors.
ii) Don’t have a cap at all and simply a discount towards the next round, 20% is fairly common.
iii) Have a graduated cap and/or discount rate, in other words those numbers change based on how long it takes you to raise the next round.
Some angels can be exceptionally value-add beyond the check and many are strong conduits towards raising more capital. The major caveat is that check sizes will likely be small, at the very least smaller than what you would get going to institutionals. Also it means your cap table will get busier, which will entail you managing more relationships and expectations.
2) Family Offices – These are in some ways straddling the border between angels and institutionals (VC, strategics etc), where someone has hired professionals to invest the wealth. Like angels, FOs have a wide latitude of practices, what they look for and how they invest is highly idiosyncratic. FOs will typically be larger checks than angels, sometimes comparable if not larger than institutionals. And like some angels and most insitutionals they may be able to provide significant help, from customers to marketing. How do you find FOs? Some provide structured ways to engage, with strong online presence, and there are lists shared around but for the most part, our experience at Tau is word of mouth remains the strongest channel.
3) Strategics – Strategics could include government agencies, non-profit foundations, corporates, among others. Tied to that is the ethos of open innovation aka sourcing ideas from both internal and external sources. Examples of open innovation: corporate venture capital (CVC) arm, accelerator, programs to work with startups etc. If you are engaging with a strategic chances are you understand their motivations behind making an investment. Oftentimes they value synergies (co-development, joint venture, potential acquisition) more than financial returns. A major caveat is raising significant strategic capital too early can limit a startup because they get too tied with certain customers, in theory and/or in practice. At Tau our general advice is to raise strategic capital mostly at or after the series A, ideally as a follow, at most as a co-lead rather than a lead.
4) Grants – Grants are often equity-free and especially useful to startups with significant IP. Getting those grants is the tricky part since the process often lasts for months if not years. Most VCs will view grant money early on, say at the pre seed or even seed stage, positively as long as there is a clear plan to raise from other sources of capital in a near future. A team that is relying on say DOD / NIH / SBIR grants for continuous funding may be fantastic but is unlikely a fit for venture capital.
5) (Bank) Loans – If you have significant metrics, especially revenues, then loans are an attractive alternative. At Tau our advice is to raise debt or a credit line alongside an equity round because it’s when you can typically command the best terms. A loan has to be repaid, usually with interest, but we find the bigger downside is it can give a team a false sense of security and lead to more expenses. As such we advise entrepreneurs to use the loan for mostly working capital or to keep it completely aside, available just in case there is an exceptional event, whether positive or negative. Also, investors are especially averse to large amounts of debt because it is senior to equity, in other words upon an exit will get paid before preferred and common shares.
Primary author of this article is Amit Garg. Originally published on “Data Driven Investor,” we are happy to syndicate on other platforms. These are purposely short articles focused on practical insights (we call it gl;dr — good length; did read). Many of Amit’s writings are at https://www.linkedin.com/in/amgarg/detail/recent-activity/posts and he would be stoked if they get people interested enough in a topic to explore in further depth. 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 our own.
