Is VC Money Always Necessary?

May 19, 2010 - Author: Peter Mui, Co-Founder of the MIT $10K Competition

Is Venture Capital Investment Necessarily a Precursor to Entrepreneurial Success?

Venture capital is commonly perceived as a integral component of the whole startup process.  We presume that startups typically go through at least one round — and probably several rounds — of VC funding as they grow.  This orientation towards outside investment affects the whole entrepreneurship ecology: for example, university-based entrepreneurial competitions — including MIT’s — get a significant proportion of their overall support from VC firms: VC firms supply speakers, mentors, judges, and sponsorship.  As such, we write our business plans, develop our business strategy, and pitch our ideas with an orientation towards soliciting VC investment.  Once launched, we set subsequent business milestones with additional VC funding rounds in mind.  The overall sense is that our path to success invariably leads through VC participation at multiple junctures.

However, in a report published last June, Paul Kedrosky at the Kauffman Foundation studied the 900 unique companies in the Inc. 500 list of fastest-growing companies over a ten-year period.  He concluded that only 16% of the companies had any outside investment. That seems like a very low percentage.

Granted, you could argue with the validity of the sample used in the study: the Inc. 500 list isn’t perfect.  E.g.: because the companies are privately held they’re largely self reporting, so independent verification of their revenue might be difficult. Also, Inc’s “fastest-growing” criteria may favor companies that start from a very small capital base atypical with outside investment.

But even if the report’s off by a factor of 2, it still means that the majority of companies the Inc. 500 list succeed without outside investment.  That’s a surprising result: what are the implications?

- Perhaps the best ideas can be bootstrapped: maybe a much smaller subset of ideas require outside investment to succeed than we’ve thought.  Sure, they may take longer to emerge as dominant, world-beating companies, but in the meantime they build a solid foundation on which to grow.

- Perhaps business plans should be oriented to be more of an operations document than a sales document designed to procure outside investment.  Business plan financials are often tailored to appeal to investors looking for quick returns — as opposed to showing how the company’s founders can use capital efficiently to sustain steady, managed growth.

- Perhaps VC funding encourages excessive risk taking across the board, leading to ineffective use of a startup’s energy, not to mention being an inefficient use of the capital stewarded by VC firms.

Focusing on pursuing and taking outside investment puts a venture on a very steep trajectory — for success, or for failure. Maybe the companies that make the Inc. 500 have adopted a more moderated approach that leads to more consistent results (For example: weren’t we always told to focus on servicing customers’ needs first and foremost?)  Having a business idea vetted by outsiders is always good, but should it be so strongly oriented towards outside investment? Is it possible that the added rigor of figuring out how to bootstrap a company improves it — and its chances of long-term success?

(You can download the .pdf Kauffman report in its entirety here: http://www.kauffman.org/newsroom/venture-capital-industry-must-shrink-to-be-an-economic-force-kauffman-foundation-study-finds.aspx)

Have feedback on this post?  An idea for a follow-on post?  Comment below or email me at: peter at alum.mit.edu.

Peter Mui is founder of the MIT Entrepreneurs Club and co-founder of the MIT $10K Entrepreneurial Competition. He’s been involved in numerous startups, taught entrepreneurship at UCSF, and has judged business plans and mentored teams at MIT, UCSF, UC Berkeley, UC Davis, University of San Francisco and Babson College.