VC & Angel Investors – What is going on with the Numbers?

One of the first things that people associate with technology companies and the early stage community is Venture Capital (VC) and Angel Investors. There is almost something mythical about them; often stereotyped as an eccentric group of connected families and wealthy individuals who have special insight into the market. They operate behind closed doors, rub elbows with movers and shakers in the community, get investment returns that the rest of the rank and file population only dream of, and transform entrepreneurs into millionaires.

The WTIA had two events in January to help shed some light on the VC and Angel community and its inner workings.   One of the events was a conversation between Tom Alberg from Madrona Venture Group and renowned author, economist, and VC Bill Janeaway. Bill has unique and varied insight into the early stage community, blending his deep experience in academia (PhD in economics from Cambridge) with his career as a venture capitalist at Warburg Pincus.

In his book, “Doing Capitalism in the Innovation Economy” he provides a commentary on the current state of the VC/Angel ecosystem and offers insight into the historical performance of VC & Angel groups. One of Bill’s major points and most concerning statistical facts was that VC & Angel organizations have realized similar returns to that of traditional investment options (think stocks, bonds, and real-estate) post 1999.

How can this be?  VC and Angel investments are supposed to be “high risk” capital that provide above average returns. Bill referenced returns with multiples of 3, 4, and even 5+ times invested capital in the 90’s. How could performance post FY 1999 be so sub-standard? Is it a lack of ideas from the entrepreneur community, other competing financing sources, unfavorable political environment, economic recession or is it possible that the VC and Angel community doesn’t have “mythical” influence and special insight so bestowed upon them after all?

My answer is that it may be none of the above.

The “2C’s” – Cash flows and Control

Whether the ideal outcome for a start-up founder is to scale organically or grow through equity infusion, the two huge philosophical concepts that need to be thoroughly thought through are cash flows and control.

Cash Flows– It can be entertaining as a finance professional to review cash flow projections of early stage companies. The “hockey stick” projections typically show little to no revenue in the first few years of operations and then show massive revenue and profits in years 3 and beyond.   Generally required to peak investment interest, this model makes absolutely no common sense, especially when put in the context of basic life experiences.

For example, when I was ten years old I mowed lawns in my neighborhood. I talked my Grandfather into using his old lawn mower and then went out in the neighborhood and started closing business using my charm and suave sales techniques (remember I was 10 !). The neighborhood loved me because I worked cheap and smiled big. Any money I made was all positive cash flow, even after the first mow.  I literally had no costs because I talked the neighbors into paying for gas. Of course I never got rich in the lawn mowing business but it taught me a valuable lesson about the importance of cash flow and motivation.

My philosophical bias is that humans are motivated to make money as quickly as possible with as minimal effort as possible. It is in pursuit of this ideal (positive cash flow as soon as possible) that most successful ventures are created.

When I look back at my lawn mowing experience with what I know today, I would have contracted out all of the work, negotiated a recurring royalty split with my subs and focused my time on growing the pipeline of customers in the neighborhood. I can guarantee you if I had to do a cash flow projection, even at 10 years old, it would have showed positive cash flow in year 1!

Control – Many founders believe that their business idea is huge and needs significant capital before it can generate cash flows and ultimately large returns.  As such, their starting point is to raise capital rather than asking the question, “What is my business, who am I serving, and what do I need to do to make it grow?”

Many technology innovations will not need to scale to a magnitude that requires significant invested capital.  This is especially true in the ICT sector and specifically with software publishers as the real start-up cost is “labor”.  Unlike manufacturing or even life sciences, the barrier to entry for founders in the ICT space typically does not involve acquiring capital assets or performing deep R&D. Rather the barrier to entry is merely creating a quality product or service that people need or want.

Which brings me to my other philosophical argument: The human brain is conditioned to be motivated to be in control. It is also in the pursuit of this ideal (being the master of your own ship) that most new business ventures are created.

I see it every day when I walk into the office, hang out with family or enjoy a drink with my soccer buddies after a game. The motivation of control permeates our existence. Why would a founder ever want to remove control from the equation when trying to execute and create something that they had the vision for? This should always be a last resort tactic, truly reserved for those with innovations that require significant sums of capital.

So What Should an Entrepreneur Do – Be Reasonable!

Everyone wants to be the next Bill Gates or Jeff Bezos with a business innovation that changes the economic landscape as we know it.  As an aside, my unicorn delivery service is going to disrupt and change the market as it exists today because flying unicorns are awesome and travel at speeds much faster than traditional transportation options.

All kidding aside, I encourage entrepreneurs to look in the mirror and ask the question, “Should I really take money and do I need it?”  If the answer is still yes than hopefully you have a game changer. If that’s the case, you can count on the fact that the Angel and VC community will be waiting in the wings!

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Mike Monroe is the Vice President of Finance and Operations with the WTIA, where he oversees all finance, accounting, human resource, operations, risk management, and IT functions.

Prior to his work with the WTIA, Mike’s career focused on the technology industry, starting in public accounting as an auditor. Mike shifted his focus to consulting, performing business valuations and other financial services. After organically building his own business, Mike accepted a CFO position with a Ql2 Software and then took a position as the head of Finance and Operations with the Seattle Storm, a professional women’s basketball franchise.