Raising venture capital is not an end to itself. Capital is an enabler. Not every great company needs to raise outside capital to be successful, but some do, and that’s the world that we participate in as venture capitalists.
I find that capital gets talked about a lot in blogs in terms of things like runway, getting to profitability, solving the VC math equation, etc. But primarily, I think capital for early stage companies should be discussed in an offensive manner. As my partner David likes to say “capital is a weapon”. It’s true that sometimes too much capital creates tons of issues, but if wielded appropriately, capital is very much a part of a company’s offensive arsenal.
We think about this quite a bit with our portfolio companies as they scale. As seed stage investors, we find that we tend to prefer modest sized rounds early on to focus a team and establish discipline around being excellent at one thing and proving things out efficiently. But beyond the seed stage, capital is primarily about winning and winning big. We look to invest in GOLAZO companies with capital efficient beginnings, and usually, those types of companies do take in a fair bit of capital and use that capital as a weapon. Typically, this happens in some combination of five ways.
1. Solidify Network Effects. This is pretty obvious. If you are building a marketplace and things are working at small scale, you would want to invest big $$’s behind growing the market quickly. Each incremental node in the network increases the value of the entire network, so capital can be useful to accelerate this growth either directly by acquiring buyers/sellers or indirectly by allowing the company to maintain low fees and burn money in the short term while the network is being built.
2. Geographic Expansion. Some businesses don’t have great network effects, or if they do, those effects really only exist at localized scale. Groupon, Uber, Taskrabbit, GrubHub and the myriad of other local-services oriented companies are examples of this, at least early on. If you have hit on something that is working in an isolated geography, it’s relatively easy for another competitor to get some scale in another market unless you get there first. So capital is a weapon to scale geographically much more quickly than the cash flows of the business would allow.
3. Data Scale. This is an internet version of economies of scale. For many businesses, the more data that you have, the better or more cheaply you are able to deliver your goods or services almost by definition. Companies that exhibit this include advertising technology companies (eg: more unique data leads to better performance), financial services companies (eg: more data leads to better risk models leads to lower costs), and many many others to varying degrees.
4. Buying Credibility. Credibility matters for many companies. If you are selling software to enterprises, those companies will want to believe that you will actally be around in 5 years and can meet the levels of service they require. If you are playing in a regulated space, capital and credibility helps you get difficult deals done, or avoid getting taken advantage of by incumbents, or allows you to invest in the things that are required to help you avoid getting sued.
5. Boxing Out Competition. Some companies are able to raise a huge amount of capital relatively early on, making things much more difficult for competitors. These companies drive up the cost of customer acquisition for everyone, drive up the cost of acquiring talent, soak up the attention of the media and BD partners, drop prices, scare off other VC’s who don’t want to short fund the #2 player, etc. An old colleague of mine used to call this “sucking the oxygen out of the room”.
Each of these are reasonable and potentially effective tactics. Pretty much all companies that scale quickly with venture capital employ some combination of these. But they aren’t foolproof, and things can often go wrong too (that’s the subject of another blog post). Raising capital has never been an indicator of success, but if used appropriately can be a critical weapon in becoming more successful faster.