I live in Silicon Valley, the birth place of Apple, Google and Facebook and the Mecca of angel investments and venture capital. I also make a fair number of angel investments every year. I get asked all the time by business owners how to raise money from angel investors and venture capitalists. I am going to make this post short. The truth is, most typical businesses are not good candidates for angel investments and venture capital. After all, only about 1 in 40 companies which seek angel investments and 1 in 400 companies which seek venture capital successfully get the funding.
Can you grow your business to $10M a year?
In general, the basic requirements for angel/VC funding can be broken down to 3 parts:
a) High Growth (Potential): Angel investors want to invest in a business that can potentially grow to $10M annual revenue within 5 years. Venture capitalists want even more. They typically only invest in businesses with $100M annual revenue potential. You might be skeptical about this but here are some examples of successful venture backed companies’ revenue in 2014 — Facebook: $12.4B , Twitter: $1.4B , LendingClub: $213M. A large percentage of these promising companies didn’t fulfill the promise, but they share the same trait: they offer a service/product that can potentially be either have a very high ticket price (enterprise) or used by a very large number of people (consumer). A typical small business such as a mom-and-pop restaurant or a hair salon won’t meet this criterion and hence won’t qualify for angel or venture capital funding.
b) Scalable Business Model: Related to high growth potential, angels/VCs want to invest in businesses that can scale. This usually implies negligible incremental customer acquisition cost relative to life time revenue when adding a large number of customers. A mom-and-pop restaurant is a counter example because their business scale is limited by the number of orders the kitchen can churn out. On the other hand, Facebook incurs very small incremental cost when adding 1,000 advertisers to their platform. My business spent $1500 a month on Facebook Ads and we never spoke to anyone on their customer service team. This is the power of a scalable business model. Not many businesses in the world can have this kind of scalable business model. Businesses which can typically have huge market capitalization.
c) Founder Reputation and Network: In the Angel/VC funding world, investors bet more on the jockey than the horse. This means that they invest in people more than the idea because it is the team that ultimately makes the business work. You would have to convince investors that you have the right team to solve a big and meaningful problem in the world and make a profit. It’s an art to convince investors. It typically means you have excellent relevant track record from your previous endeavors or you have built something amazing that you can show to them. In addition, you need to have the network to bring the product/service to their attention.
Conclusion
It’s a well-known secret in the VC world that only ~15 companies per year are started that will ultimately succeed as a unicorn business (with $1B+ valuation). There are a lot of venture deals being funded per year but VCs’ ultimate goal is to identify these unicorn businesses early. Angel investors usually have a more attainable goal but they still expect businesses to generate millions of dollars in revenue to make a good return on their investments. It’s fairly uncommon for a business to fit the mold for angel/VC funding. If you can meet the requirements mentioned above, it might be worth pursuing. But realistically, most businesses can only use their own financial resources, friends and family financing, and debt capital for expansion. In addition, you will be giving away a piece of your business and sometimes lose control of it when obtaining angel/VC funding. You have to think whether it’s the right funding option for you and if it’s worth spending all the time and resource to pursue it. For 95+% of businesses, the answer will be No.
Related Reading: Demystifying Venture Capital Economics
This article was originally written on April 10, 2016 and updated on November 3, 2016.
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