As a startup founder, you really need to understand how venture capital works – TechCrunch

Before getting up As a cash-strapped fledgling startup, it might seem like all the problems you’re having would go away if you just had cash in the bank. At TechCrunch, it often seems like every other startup story is about another fun company raising bags full of venture capital.

Millions — billions — of dollars are pouring into upstart tech companies of all stripes, and as the de facto clearinghouse for the startup ecosystem, we’re as guilty as anyone of being a little on the ‘cult’ side. capital” of things. One truth is that successfully raising capital from a venture capital firm is an important step in the life of a startup. Another truth is that VC is not suitable for all businesses. In fact, there are significant downsides to raising funds from VCs. In this article, I examine both sides of the coin.

I have two working days. One is a pitch coach for startups, and the other is a reporter here at TechCrunch, who includes writing our incredibly popular Pitch Deck Teardown series. Before those two-day jobs, I was a portfolio director at Bolt, a hardware-focused venture capital fund. As you’d expect, that means I talk to a lot of start-ups and I’ve seen more pitch decks than any human should.

A lot of the pitch decks I see, however, make me wonder if the founders really thought about what they do. Yes, it’s sexy to have a boatload of cash, but cash comes with a catch, and once you’re on the VC-powered treadmill, you can’t easily back off. The corollary of this is that I suspect a lot of founders don’t really know how venture capital works. This is a problem for several reasons. As the founder of a startup, you would never dream of selling a product to a customer you don’t really understand. Not understanding why your VC partner might be interested in investing in you is dangerous.

Let’s see how it all comes together!

Where VCs get their money

To really understand what happens when you raise venture capital, you’ll need to understand what drives VCs themselves. In a nutshell, venture capital is a high-risk asset class that money managers can choose to invest in.

These fund managers, when investing in venture capital funds, are referred to as limited partners or LPs. They sit on top of huge piles of money from, for example, pension funds, university endowments, or the deep coffers of a corporation. Their job is to make sure the giant pile of money grows. At its lowest, it should grow in line with inflation – if not, inflation means that the purchasing power of this pool of capital is declining. This means several things: the organization that holds the money loses money and the fund manager is likely to be fired.

So the lower end of the range is “to increase stack size by 9% per year” to keep up with the current rate of inflation in the United States. Typically, fund managers fight inflation by investing in relatively low-risk asset classes, a strategy that works best in low inflation environments. Some of these low-risk investments may go to banks, some to bonds, while some will go to index funds and trackers that keep pace with the stock market. A relatively small slice of the pie will be reserved for “high risk investments”. These are investments that the fund can “afford” to lose, but the hope is that the high risk/high reward approach means that this tranche doubles, triples or beyond.

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