In this podcast, we talk about two big local money deals that were just announced and try to figure out who’s getting the better end of the bargain.
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Episode 2: I Get By With A Little Help From My Friends
In this podcast, we talk about the importance of the startup ecosystem. From providing cohorts and mentors to creating a culture of expertise, the startups around you will have an effect on whether you succeed or fail.
This can be challenging, because building relationships with people who aren’t your consumers or your backers can feel off-task, but that support system can help in ways you can’t anticipate. In our example, we talk about a local Birmingham neighborhood where retail storefronts looked out for each other.
How Small-City Startups Can Get the Funds They Need
Small cities can be uniquely positioned to help startups get up and running. With lower costs to operate, less competition for resources, and high levels of public interest in new companies spinning up, smaller markets can be great incubators. Despite those tailwinds, companies in smaller cities often struggle to find private investment funding. It’s not that there isn’t any money to be invested—quite the contrary. Most metropolitan areas have at least one anchor industry creating wealth that spans multiple generations. Economic development organizations bring public money to the table as well.
Creating a minimally viable product and proving market traction are normally required before a startup lands sizeable investment money. Building that MVP and proving market validity takes time and money that many new ventures don’t have.
When founders decide to take on a funding partner, they often think in terms of securing $500k or more. That kind of investment falls in a gap that normally goes unfunded—too small for institutional investment and too big for individual investors. Pre-revenue startups who want to raise a year’s or more worth of runway in a single round are often left without any dance partners.
The fragmented nature of private individual investors, relatively finite size of public money offering, and the follow-on investment plays of institutional funds perpetuate this seed funding gap.
Overcoming this gap requires founders to change their thinking.
Step 1: Take a strategic look at what it will take to create the MVP. Consider what kind of money and resources it requires, and strip out anything that isn’t absolutely crucial.
Step 2: Determine how you’ll prove market traction. Whether that includes landing the first customer, attracting users, or building models around credible survey data, plan for this before you ever determine how much money you’ll need to raise and how quickly you’ll need to raise it.
Step 3: Complete the financial projections to determine the amount you absolutely need to pull off Steps 1 and 2. Decide how much equity you’re willing to give up (hint: it will be more than you want to give up).
Operating under the assumption that this seed funding won’t get you very far—only to the point of launching an MVP and proving market validity—the new funding number is likely far smaller than $500k. If the numbers fall between $50k and $120k, you could very well find an individual investor or small group of investors who shares your vision and is willing to risk cash in exchange for a sizeable chunk of equity.
Once you’ve launched the MVP and proved market traction, the size and options for investment funding expand. Not only will local sources of investment be more readily available, but investors from other cities, areas, or regions may be more approachable as well. Closing the funding gap is something pre-revenue startups can do for themselves as long as they tailor their timeline, product development, and overall approach to the funding sources available.
Venture Capital May Stop Unicorn-Hunting
A few months ago, Oscar Williams-Grut wrote a great piece in Business Insider talking about the shift in investing interest from “unicorns” to what he coined “cockroaches.” His definition of a cockroach was a company that could survive anything. These were companies that were more interested in profits, self-funding, minimizing costs, and measured growth. Certainly a departure from the kinds of pre-revenue VC darlings that received massive funding in 2014 and 2015.
I was surprised that his article didn’t gain more traction and that #cockroaches didn’t become a thing.
At present, he is looking prophetic.
Theranos has all but imploded. Twitter is looking a lot less shiny than it once did. Zenefits is worth half what it was a year ago. Tesla cars are driving themselves into other objects at high speed.
During last year’s $4.2 billion spike in private investment deals, 59% of that total went to just three companies: Airbnb, Spotify, and Zenefits. There were 39 other “tech” deals in that same period for the remaining 41% of the $4.2 million. That’s a lot of investment money living in only 42 companies.
With this kind of concentration in private investment, fund-raising that used to be an incredible long-shot for the average non-valley-based startup just became impossible. At some point, the money is all spent.
Theranos, Twitter, and Zenefits could turn it around. With that much investor money involved, the sunk cost fallacy should encourage investors to pour in more cash if things get dire. If, however, these companies improve PE and VC rationalizations in value and fund-raising, that could be a very good thing for the rest of us.
Potential, rather than probability, has been favored for a long time among the millionaires providing VC cash to build various funds. The biggest of gambles were worth it because it only required 1 in 15 startup investments to actually make it. Now that ratio seems to be slipping further and private investment may find incremental growth far sexier than it did in the past. Risk mitigation, at some point, becomes a basic fiduciary responsibility and cockroach companies could benefit from that shift in investment theory.
Here are three fundamental shifts I predict could happen in the next 18 months:
- VCs start putting together “balanced” funds that act more like low-risk securities. Filled with smaller investments across more “bets,” these funds start to look for companies that exhibit clear paths to profits. This would also create a way to attract lower net worth investors to a fund.
- VC money will shelve tech-for-consumer concepts in favor of tech-for-business solutions. Private investment money isn’t willing to put down the app develop crack pipe just yet, but they will look more closely at those companies creating B2B applications as that market is, historically, less capricious.
- PE firms will be increasingly interested in finding opportunities in non-traditional hotbeds. GE Capital just partnered with Lamppost Group on their new logistics accelerator, Dynamo, in Chattanooga, Tennessee. There is a concentration of capital in a handful of places in the US, but ideas and innovation are not landlocked. The return on invested capital will be far greater in less expensive locales.
Of course, I could be completely wrong. Money can be inherently dumb and illogical. Companies who’ll champion the moniker of “cockroach” will focus on the things that make them hard to kill. Their survivalist mindset will lead to different decisions than one betting on run-rates, future value, and traffic monetization.