By Dileep Rao – Guest Contributor
Given the current habit of labeling all types of equity financing as venture capital and all ventures receiving VC as startups, things can get a little confusing.
Not all VCs are created alike and not all startups are at the idea stage. All VCs are difficult to tap, but some more so than others. Some are more expensive and others more controlling. You need to find the right VC source at the right stage if you want to create wealth and control it. Here is a guide to the key types and what they do
Savings: The first and most obvious source of capital is your own savings. Investing a large part of your savings shows your commitment to the deal. The thinking is that when your back is against the wall, you may work harder. In general, it is easier to get others to invest when you are investing all of your own money – or a significant share of it. Dick Schulze started Best Buy with his savings.
Family & Friends: Families and friends are often a key source of financing, and often the first source. Mark Zuckerberg got funding from his family to start Facebook. So did Jeff Bezos to start Amazon.com, and Sam Walton of Walmart who got funding from his wife’s family. Bob Kierlin started his giant company, Fastenal, with $31,000 from friends and his own savings. If your friends and family with money don’t support your new business, why should others? The problem with using friends and family is that you may not be welcome at Thanksgiving dinner if you lose their money.
Crowds. This is a relatively new source of funding. There are organizations out there that can put you in touch with crowds who invest small amounts of equity. These organizations include companies like Kickstarter and Silicon Prairie. Often these investors like your product (or proposal) and are willing to take a small risk on you. Ocular Rift started this way.
Angels: Angels are a different form of crowds and there are many angel groups around the country. They are often a good source of funding for entrepreneurs, if you can get them to invest, since each angel usually invests small amounts and often does not demand control. Make sure you have a good securities lawyer. One way to get angels is to get a bell cow who is well known, has a good reputation, and has made money. Can you find a lead investor who knows you, knows your industry, is willing to invest, and can attract other investors who invest.
Sophisticated Angels: These are angels who invest larger amounts, offer expertise, but sometimes turn out to be sharks and seek control of the venture and the wealth created. Watch out.
Corporate Alliances: These can be an attractive source because they have capital, industry connections and credibility. Michael Bloomberg used a corporate alliance with Merrill Lynch to build his company and one of the world’s great fortunes. Done right, alliances can be a great source of funding.
Small Business Investment Companies: These firms are funded by the Small Business Administration and often offer growth financing. They were the leading group of VCs before the VC limited partners burst onto the scene.
Targeted VCs: These are often non-profit VCs that are funded by governments, foundations, and local areas to promote growth ventures in targeted communities, such as low-income populations, or minority- or women-owned entrepreneurs. They may be a good source if you qualify, if you need smaller amounts, and can benefit from cheaper financing.
Lower-Rated VCs: These are often the smaller VC limited partnerships and regional VCs outside Silicon Valley. They invest smaller amounts than the larger, top 3% of VCs – and may not be able to offer you sufficient financing, especially if you are competing against better-funded ventures with financing from a Top 3% VC.
Top 3% VCs: These are the elite of the VC community, and use “Capital-As-A-Weapon.” They are large and have multiple funds under management with amounts ranging from hundreds of millions to billions. They have global networks and are your best source if you want to build a unicorn with VC. According to Andy Rachleff, they account for 95% of VC profits. Silicon Valley has a lot of these VCs.
With each type and mix, you need to get the right amount by stage to help you grow with reduced cost and dilution. Make sure you stay in control – if not, you may end up on the outside of your venture looking in.
MY TAKE: Find the equity source that will let you both grow and control the direction of the venture and of the wealth you create. If you want “real” VC that offers Capital-As-A-Weapon, you need Institutional VC from the top 3%. They are very selective, and they can be very controlling. Learn what 94% of unicorn-entrepreneurs did — they avoided or delayed VC to control their unicorns and to keep more of the wealth they created. Not many build two unicorns. That’s what makes Jobs and Musk rare.
This column was first published in Forbes.
Dileep Rao is the author of Finance Secrets of Billion-Dollar Entrepreneurs (FIU Business Press, November 2020) and teaches entrepreneurship, unicorn-entrepreneurship, and venture financing at Florida International University. He is a former venture financier.
READ MORE from Dileep Rao:
- 7 THINGS WE CAN ALL LEARN FROM JEFF BEZOS, THE ENTREPRENEUR
- WHAT CAN YOU LEARN FROM AIRBnB: FOCUS ON YOUR SKILLS, NOT THE IDEA
- WHY 100% OF VENTURE CAPITAL CAN BE EXPLAINED IN ONE 4-LETTER WORD
- HOW FINANCE-SMART ENTREPRENEURS FIND FINANCING IN A FINANCE-SHORT WORLD
- GRIT V. GLAM: THE 2 FACES OF BILLION-DOLLAR ENTREPRENEURSHIP