In the game of startup funding: Is VC the trump card, or are you really playing the Joker?

In the game of startup funding: Is VC the trump card, or are you really playing the Joker?

Venture Capital has long been seen as the trump card of funding. And this perception has created an infatuation with raising capital from VCs, equating achieving it with startup success. But the reality is, VC isn't the only option for founders looking to raise investment. In fact, as we’ll explore today, considering alternatives might just be the ‘ace up your sleeve’ you were really looking for.

Before we get into it, it’s worth noting that we are absolutely not anti-VC funding. VC represents a vital, and sometimes the only viable, source of funding for some businesses. But for a startup undertaking their first few funding rounds, they are rarely the optimal, or indeed even a feasible, choice.

While some startups do close their first funding rounds via VCs, it is rare. And there’s few good reasons for this:

1. First round businesses are usually ‘too early’ for VCs. VC investors usually seek well-established businesses with proven traction - something most startups don't possess during their initial stages. Some VCs claim to invest in ‘early stage’ but often when you scratch under the surface and you find that ‘early stage’ means £50k monthly recurring revenue (MRR). Countless startups waste countless hours chasing an early VC investment.

2. The terms on offer from a VC will be much worse than the alternatives. The amazing (S)EIS schemes are meant to support your business with early rounds. In general, terms requested by angels are constrained by the (S)EIS rules, which stipulate that the investors shares aren't allowed to have anti/no-dilution protections, or liquidation preferences etc. VCs have no such constraints, and in fact some of these terms are ‘market standard’.

3. While VC investments are increasing, it’s among scale ups, not startups. This means accepting VC money often means giving up a significant degree of control and accepting unfavourable terms. Liquidation preferences, anti-dilution measures, monitoring fees, and board seats are just a few of the strings attached. These terms might not align with the founder's vision or interests.

And then there’s the least understood, but biggest factor: power-law

A major consideration should be power-law: a concept lots of founders just don't understand enough about.

The power-law is a principle that VCs essentially spread bet their money – in the hope that just one of their many investments yields returns larger than all other investments combined. A founder’s aims, and indicators of success, are entirely different.

This approach of ‘swing for the fence’ by taking bold bets, means with every investment they are aiming for that elusive "Unicorn”, or bust. This is fine if you're the VC with a big portfolio to play with (“hedge their bets”) and you are able to rely on the power-law to provide exceptional fund returns. But startup founders don't have that big portfolio to play with, they've only got their startup. What’s essentially a low-risk numbers game for the VC is a one-shot chance for you.

And unlike them don't need to hit a 10x return to reach a life-changing outcome. The power-law creates a tension between what founders would consider a great outcome (building a business to £50m, having a 'champagne exit' and becoming a multi-millionaire) and this being seen by VC as an abject failure.

So, what is the alternative?

Before pursuing any form of funding, founders should reflect on their long-term goals. Each funding option has its own cost of capital and implications. Knowing what you need and what aligns with your vision is crucial.

But, in a nutshell? There are two ways to do it. 1) bootstrap or 2) modest level of angel investment), get to seven or eight figures revenue in a few years and exit, sprinkling millions amongst stakeholders. It’s far more likely to achieve that this way, than via VC.

Let’s look in more detail at what both those terms mean:

Bootstrapping: Bootstrapping your startup means relying on your own resources and revenue to grow. While it can be challenging, it allows you to maintain full control and avoid the pressure of rapid scaling.

Angel Investors: Angel investors provide capital and, perhaps more importantly, mentorship and guidance. Their personal involvement can be a tremendous asset to early-stage startups. Additionally, they might offer more favourable terms and flexibility compared to VCs, a route which doesn't make use of a founders super-power in the UK, SEIS / EIS. Angel Investors in this context come in lots of flavours - from family and friends, ‘lone’ angels, angels as part of a private equity club or angel network, equity crowdfunders (such as Seedrs and CrowdCube), and finally SEIS and EIS funds (though watch the terms here, specifically).

The key takeaway

My key piece of advice is this. Work out what game everyone is playing. Because chasing VC could mean you’re falling into the trap of a game you didn’t realise you were playing.

Instead, consider a different path. VC is just one tool in the startup’s toolkit. Explore alternative funding options that align with your vision, long-term goals, and risk tolerance.

Success in the startup world can take many forms, and sometimes, playing the right game, with the right hand, could lead to the most rewarding outcome.