Do I Need Venture Capital?

59

CHAPTER 6

Do I Need Venture Capital?

“The person who doesn't know where his next dollar is
coming from usually doesn't know where
his last dollar went.”
Anonymous

T he primary source of capital in the early stages of the life of any busi-
business is the founder entrepreneur. If there are other members of the
founding team, then the venture’s initial funding will come from them in
the agreed ratios.
In general, the other sources of funding include the following:

Family, friends and well-wishers;

Leasing finance;

Bank loans;

Angel capital;

Venture capital.

Each of these sources of finance:

Has a limit or a “cap” on the amount that can be provided;

Is “enabling money”, required for meeting specific purposes to enable
the venture to move to the next stage of growth of its lifecycle;

Is required and can only be obtained at the specific stages of the life-
cycle of a business;

Is invested in the business for a specific time period;

Has a distinct risk profile; and

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60 Smooth Ride to Venture Capital

Seeks returns to compensate it for the risk taken.

The Funding Gap

In the initial stages of a venture, there often arises what is called a fund-
ing gap. This is a period in which the venture can neither attract debt fi-
nance nor can it get venture capital funding. Debt finance from banks is
not available as the business only does not have established cash flows
and its future cash flows are also uncertain. The founders finance the
company through personal savings or take credit based on their personal
credit history. Investor capital is also not available as the venture is not at
a stage where it can meet the VC’s funding eligibility criteria. This fund-
ing gap is managed by the founders by what is referred to as bootstrap-
ping, that is, relying entirely on one’s own efforts and resources to fund
the business.
Each venture passes through certain stages of development during its
lifecycle. At each stage, the business performs certain specific activities
and requires money to complete those activities. A detailed explanation
of the stages of development and the requirements of business at each
stage was provided in Chapter 4.
You should determine the stage of your business and define the pur-
poses for which the money will be used. Then look at all the other ave-
nues of obtaining the money, before embarking upon the venture capital
raising process.

Do You Really Need the Money?

Whatever the stage of your business, the sine qua non of funding your
business is managing money well. Before you start seeking money from
any source, you must review your money management style. You must
also evaluate whether you are optimally using all the financial options
available to you.
Money that is invested in your business from outside always has a cost
associated with it. You should, as far as possible, try and avoid getting
funding in exchange for equity early in the lifecycle of the venture as you
would have to give away a larger chunk of your equity for relatively
smaller amount of financing at that early stage.
 Do I Need Venture Capital? 61

Therefore, before approaching anyone for funding your business, re-

view all the alternatives that may reduce the very need for funding or
make funds available to you through creative means. Try and use boot-
strapping skills before embarking on a VC hunt for your business. You
must have a demonstrated record of frugality in the use of your financial
resources before you approach a VC or any other investor. Table 6.1
provides a list of some creative financing ideas which you can use.

Table 6.1
Creative Financing Ideas
1. Find ways of sharing your expenses with other people. Using shared premises
or subletting your premises till such time you require the extra space are examples
of reducing the fixed cash outflow on your business infrastructure.
2. Carry minimum head count on your payroll. Use contract or part-time employ-
ees for non-critical activities. Better still, outsource the entire function which is non-
critical and perform only those activities in-house which are your core competence.
3. Structure performance linked compensation for employees to eliminate
need for high starting salaries. Also, add stock options to your compensation
plan. The employees will then see a potential upside to their overall compensation,
while you will reduce your cash outflow
4. Don’t block your money in fixed assets. Lease the assets you need rather than
buying them outright with your cash resources. Also, acquire only those assets that
you really need, leave the fancy stuff for the time when you start generating cash
profits.
5. If your business requires investment in carrying inventory then do ensure
that you have in place an efficient inventory control system that ensures
minimum carrying costs. Measure your inventory costs with industry average and
put in place processes to optimise the costs based on such industry norms.
6. Suppliers can be a cheap source of funds. Structure their payment terms in such
a way that your business is funded by their credit.
7. Look for ways in which customers can pay you in advance for your services.
Your payment terms should be structured in such a way that by time you deliver
your products or services, at least 80% of your order value is back in circulation in
your business.
Contd . . .

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8. Structure your sales commissions in a manner that the sales staff are hooked
on to the clients till the cash is realised. For example, if you are paying 2% sales
commissions to your staff, then pay 35% of the commission amount on order
booking, 35% on delivery, and the balance 30 % on cash receipt of the complete
invoice value from the customer.
9. Create a “cash is king” consciousness in the organisation. The best way is to
reward your accountant on the basis of the DSO (“days sales outstanding”) of re-
ceivables. The whole process of invoicing to cash collection will get covered in this
indicator. Invoice promptly, follow-up and sort out customer queries quickly, facili-
tate the movement of your invoice in the client organisation proactively, and get the
money back into your business as quickly as possible.
10. Develop strategic alliances or joint ventures with suppliers and customers.
Alliances with suppliers would help you in better supply lead times, improved qual-
ity, and quicker product development, apart from better pricing and credit terms. A
strategic alliance with a customer would benefit in many ways in providing cash for
your business, for example, advance payments may be made to fund your develop-
ment or working capital requirements.
11. Use your idle capacity for bartering services. For example, if you are running a
software company and have a couple of staff who are not fully occupied, let them
be involved in doing some free work for your lawyer or accountant in the IT do-
main. In exchange, you may get extended time from them when you really need
their expertise.

Can You Get Bank Loans?

Bank loans are a much cheaper source of finance than are VCs. The cost
of raising bank loans is negligible as compared to raising investor capital.
The loan money itself is cheaper to service as it carries a fixed rate of in-
terest related to the existing inflation rate. However, loans are taxing in
terms of cash flow. They require regular cash outflow. If you can afford a
loan in terms of cash outflow and think that you can qualify for one,
then you should consider this source of finance
Generally, loans are not available at the seed and start-up stages of a
business, where you may only be able to get lease finance. In the early
growth stage of the business, however, loans can usually be arranged.
Term loans to purchase capital assets and working capital loans for man-
 Do I Need Venture Capital? 63

aging the shorter term funding requirements should be availed of before

going out to look for venture capital. You must remember that VC
money becomes cheaper as the venture grows. Hence, try and defer VC
funding till as late in venture’s growth stage as possible.
To summarise, you should start the process of raising venture capital
only if you have exhausted all other sources of financing. You must also
be creative in your use of financial resources — make sure your every
buck travels that much more. At every stage of the business, prepare a
forecast of expenses required for moving to the next stage of growth.
Then evaluate the available sources for funding the requisite capital. And
all through the process, remain frugal and creative in using your financial
resources.
After you have exhausted all your financing avenues, creative or oth-
erwise, you will reach a stage at which you will feel that raising venture
capital is required for further growth of your business. However, you
may still harbour some irrational fears about motivations and the work-
ing style of the VCs. The next chapter addresses the typical fears that
most entrepreneurs have about VCs.