Home > Entrepreneurship, Venture Capital / Private Equity > When to say “no” to a VC/angel?

When to say “no” to a VC/angel?

Often, there are good reasons for not taking VC money even when they are beating down your doors.   Some of them are as simple as preserving ownership and maintaining the status quo in what has probably become a lifestyle business.  Others can be slightly more complicated so I am thinking about writing up a set of real life examples where I have advised entrepreneurs to eschew the easy security offered by institutional investors.

Case Study:  Small exits more likely than large exits

An entrepreneur I have been tracking has a very cool and timely technology product based on defensible intellectual property.

Specifics of this particular business (optional reading):

  1. The product has a 2 year window to be monetized beyond which competitors and substitutes will likely subsume it.
  2. In real terms, this is a “feature” technology and not a standalone product on its own.  It is an intellectual property play.
  3. The technology can be licensed today to large OEMs and possibly make a few million USD in royalties/fees.
  4. Including the main market and possible adjacencies, I would size the revenue opportunity to be $1M  (probability of 80%) to $5M (probability of 20%) per year in the best case.  The revenues will likely dwindle after two years as competitors move in.  The upside scenario is a broad patent award (unlikely) that can be more lucrative.
  5. There are no comparable transactions which would indicate similar technologies have produced large exits
  6. Although any rational investor would have similar concerns, there are some who would want to invest in his business.

Now, the founder could take VC or angel money (the valuations are not too relevant), but as soon as he does so, a new reality will dawn upon him:

  1. Without the investor: The founder can execute a couple of large OEM deals or even sell out for a small amount of money (e.g. $2M to $5M) and be fairly happy with the outcome.
  2. With an investor: The company is one of a portfolio of many, and early stage investors seek several multiples of their post-money valuation as a return from every company.  In doing so they usually adopt strategies to execute on aggressive plans so that a few of their portfolio companies produce large returns, most perform average and several perish trying.  A $2M exit will not be acceptable to the investor especially if the valuation he has invested in is anything more than $500k post money(or thereabouts).
  3. Although the investor may own as little as 10% of his business (usually much more),  the investor’s rights may imply complete control on how the founder executes on his business plan and more importantly his ability to exit the business.

My two cents of advice to this particular entrepreneur was that he stick to FFF (“friends, families and fools”) for any immediate but small capital needs he may have and try to run and exit the business on his terms.  He can pocket a decent sum of money and look forward to building something bigger the next time around.

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