Are you raising the right type of capital for your venture?
- Author: Anirudh Damani
- Posted: April 28, 2018
In a May 2017 post, The math of early stage venture capital, I had explained the aggressive the return expectations for an early stage VC (the “impatient capitalist”). One of the biggest mistakes a founder can make is to raise impatient capital for a business model that requires patient capital. The incorrect choice of capital leads to an expectation mismatch on the pace of growth the venture will achieve, between the founders and investors. So, while the founder could be happy with the upwardly inclined growth plane his business is achieving, this rate of growth might not be aggressive enough to command a higher valuation in new funding rounds thereby disappointing the investor. A dissatisfied incumbent investor is toxic to future fundraising plans for the founder.
Patient capital is often misclassified as impact capital which is a grievous error and in my opinion, a leading cause of its low acceptance rate with founders. Unlike impact capital that demands a nominal rate of return and is inclined towards capital preservation and social impact, patient capital has aggressive IRR expectations. In fact, if I drew a vertical line that has impatient capital at the top and impact capital at the bottom, patient capital’s IRR expectation would be in the 65th to 75th percentile of that range. In a nutshell, patient capital is expecting fantastic, market-beating returns. The key difference between patient and inpatient capital is that the patient capitalist is comfortable with long periods between funding rounds and he/she is comfortable (and experienced) in holding investments for very long periods of time.
The patient capitalist reduces the pressure on founders to deliver 30-50% QoQ returns that an impatient capitalist wants (read: The rule of 3x). They refocus both their own and the founders energy on enterprise development, sustainable growth and brand building (internally & externally). The obvious sources of patient capital are family offices, corporate venture capital, private equity funds i.e. sources that do not need to return capital for long periods of time.
However, there is a price that a founder pays for raising patient capital. Firstly, patient capitalists do not like giving lofty valuations. Secondly, they do not allow burning of copious sums of money on marketing/PR/recruiting activities that chase runaway growth. Thirdly, (and most importantly) patient capitalists tend to acquire the investee businesses at a certain point in the future. A founder can view these shortcomings as small prices to pay for the freedom that patient capital provides but they will be fools to raise such capital if they possess a business model with explosive growth potential, just for the freedom that it temporarily provides.
Therefore, it is the founder’s duty to classify what type of growth his/her business will provide and align themselves with the type of capital that best suits that business model’s expectations. Are you raising the right type of capital for your venture?