The short answer is probably not.
This has nothing to do with you or your business. It has to do with statistics. The last time anyone counted, the rate of new business incorporation in the U.S. is about 565,000 incorporations per month or 6.8 million. The rate of institutional venture capital fundings according to the PWC Money Tree survey was 4,430 in 2014. Taken together that means institutional venture capital firms financed 0.06% of news businesses last year.
And speaking of numbers, here a simple seven point test to help you decide if you should try to run the gauntlet.
1. Are you a technology company? In 2014, just 346 institutional venture capital transactions, or about 8% were in for companies engaged in financial services, retailing or consumer products/services.
2. Are you capable of being a market leader? Venture capitalists are reluctant finance a company going up against a market leader because it’s too difficult and too expensive to succeed by stealing share from a well entrenched and larger company. Shake Shack demonstrates you can succeed with something as simple as a hamburger, but investing a category and dominating it is far more attractive. Think Facebook, Google, OpenTable, LinkedIn.
3. Can your company be built inexpensively? There’s probably money to be made building hydro electric plants in China, but $10 billion per project is too steep. For a firm with a billion under management, who invests alongside other firms, $100 million to $500 million is more in the sweet spot.
4. Does your company need enough capital? This is the flip side of number 3 above: Will building your company require enough capital? A company that needs just $500,000, for institutional venture capitalists with $50 million to invest per opportunity (across several rounds), it’s usually a pass. Reason: One hundred $500,000 investments is harder to monitor/help/launch than 5 or 10 investments.
5. Can the company be acquired or go public? It’s not just whether or not a company can take this on. Are the principals willing to do it? Some business owners worry about generational and family issues. Others might be happy to stop after reaching $100 million in revenues with a nice margin attached to it.
6. Can the product or service generate gross margins of more than 50% and operating margins of at least 30%? A 20% or 25% operating margin is a wonderful accomplishment. However, for companies where the receivables and the customer base are nascent, there’s a lot of variance (read risk) and baseline operating margins below 30% can get very thin very quickly.
7. Can the company deliver $50 million in profits in five to seven years? Fifty million is an important threshold. Here’s why: $50 million multiplied by the S&P Technology Sector price earnings multiple of ~ 20x equals a valuation of $1 billion. While there are public companies valued substantially less than $1 billion, to achieve the liquidity that lets venture investors sell their shares, and the visibility that enables price appreciation, $1 billion, in today’s institutionally driven markets, seems to be the price of admission.
Of course there’s exceptions. An acquisition doesn’t require a public offering. And while an S&P 500 company may want to buy earnings, they might also want to buy technology with no earnings associated with it. Still, in the main, the earnings hurdle applies in many instances and is steep.
While this is a dismal analysis, it’s important to take in the full meaning of the word Institutional venture capital, which refers to large corporations or partnerships that have raised a billion (at least hundred of millions) from limited partners and who approach investing in a very methodical, institutional way. They have to since general partners are accountable to the limited partners. So, institutions are certainly a source of venture capital, and by far the most visible source, but they are not the only source. In fact, thanks to these larger venture outfits, and their success in propelling a tech sector, there are more newly minted millionaires and billionaires than ever looking to recycle their wealth into emerging growth companies. These individuals are a much more likely source of capital for your venture.
