Shifting gears | Steps to getting a new venture past the checkered flag
I’ve sometimes described the process of funding high-growth ventures as akin to race car driving. So buckle up — I’m about to wear out the tires on this comparison.
A founder creates a concept car, fuels it with capital and sweat and races for market leadership. If the founder is also the car’s driver, then the investor is both a fueling station and a co-navigator — sitting, like all navigators, just to the right of the driver, on the company’s board of directors, for example. Growth companies consume capital at a rate that requires refilling the tank every 12-18 months over a five- to seven-year period.
The first professional round of investment gets the car going, helps it pick up some speed and builds up a head of steam that attracts future investors. To follow this analogy, think of a car’s stick-shift gears as stages of development and investment. In this context, first gear is a pre-revenue company needing capital to fund development and losses. Second gear means you’ve gotten some meaningful revenue (up to $3 million or so) and require funds to support working capital and operating losses associated with growth. Third and fourth gear companies have established revenue and customers and are using capital to expand. Each gear stage has a different character of investor — private equity deals with mature companies while venture capital with more formative ventures.
Early-stage investors want to be more than just a fueling station. Going along for the ride means exchanging capital for ownership and partnership for five to seven years; like cars on highways, investors seek exits — value realization events such as sale of the company. Managing other people’s money demands that I get a front seat, such as a board seat, to help the driver stay on course and increase the odds of a successful race, however defined. Progress in this race is measured in many ways, including market leadership, efficient capital use and plentiful access to fuel on reasonable terms.
An active venture capitalist helps plot and map the course, supporting the driver by providing helpful direction and calling out road hazards. If the car stops working or slides off the road, the investor looks under the hood with the driver and provides productive and constructive counsel. Experienced investors have seen a lot of cars that didn’t work as promised, done some fix-ups, and lost and won races. It is said that “good judgment comes from experience, and experience, well, that comes from bad judgment.”
The homestretch
More often than not, the driver who built and started racing the car is not the driver to take it over the finish line. While it can be distressing to the car’s original designer, changing drivers is very common and is always done with the view to the successful outcome of the race, which benefits all members of the team.
There’s a lot of carnage in the venture capital-fueled race. Only a third of drivers VCs bet on actually finish the race, making money for founders and investors; the other two-thirds either don’t finish at all — resulting in failure and loss of capital — or finish weakly and return less than the invested cost. Many of these reasons for failure were covered in the Sept. 7 column, “Risky Business.”
Sometimes, however, market forces beyond the control of drivers and their backers create challenges for all participants. The current recession is one such factor that has made it very difficult for many drivers to continue the race. Also, providers of fuel are rationing their precious resources, reserving their capital for their existing stable of cars while investing in fewer new drivers.
A few get lucky, either having raised meaningful capital prior to the downturn or being provided capital to weather the storm and/or fund a change in direction. Others are not so fortunate. Startups often lose money for the first three or four years as they build capacity and fuel growth; those caught without reserves must go into contraction and/or survival mode. If they are lucky, they can lighten the car’s load (layoffs, more fuel-efficient designs) to make their limited reserves last longer, at least long enough to get to a fueling station with capacity and interest. Others are forced to make much harder choices — selling, or worse, shutting down. For these companies, it’s either sell to a larger, better-funded racer or scrap the car altogether.
Venture capital investing and race car driving are high-stakes games, with speed, breakdowns, wrecks, victories and everything in between. The recession has made the race longer and harder for most drivers and their partners. So if you’re planning to get in the race, make sure you know the track, have good partners with ample reserves of fuel — and please don’t drink and drive.
Michael Gurau, managing general partner of Clear Venture Partners in Portland, can be reached at mg@clearvcs.com.
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