If the headlines are anything to go by, you could be excused for thinking that every tech company simply raises millions in venture capital investment for all of their funding needs. A supposed £3.6bn was invested into the UK’s burgeoning tech scene last year by VCs. Let’s be clear: this isn’t the Valley, so that’s a very big number indeed.
But what about the other 99% of tech-powered companies that aren’t raising millions of dollars every year? Is equity investment even something they should be aiming for?
There’s no denying that VC fundraising is rocket fuel for startups, providing a concentrated injection of scaleup funding and front-page headlines. Yet what many tech entrepreneurs don’t realise is that equity funding isn’t always the best option.
Sometimes equity finance raised from VCs is just a direct transfer of wealth from the investors to customers. This is certainly the case with loss-making companies that have a low price point and are banking on the huge potential of their respective markets. But growing revenue by massively increasing costs is not always a good result and it can’t last forever. If the market opportunity isn’t there, it can all come crashing down quickly.
A massive injection of equity capital doesn’t have to be the answer for tech companies, especially those still in their infancy. I speak with many founders in the tech space every year and more often than not their funding problems mirror those of most other businesses – they need to make payroll, they need to make rent, they need to invest in R&D but they don’t have the necessary cashflow free. In other words they have the product, they maybe have the order book – they just don’t have cash.
A lot also depends on the revenue structure of a company. For a lot of tech companies, the flow of cash into the business is far from even. Think of an app design studio: big, lengthy projects, that won’t see a financial return for months, maybe years. Even software companies that offer their product on a subscription basis might not break even on a customer for many months, so there’s a massive money gap in the interim. Many tech companies are based on these revenue models and have huge cashflow problems as a result. The rocket fuel of equity finance can solve that problem in the short-term but it’s expensive. There are better solutions out there.
Tech companies are raising funds to disrupt industries from taxis and dry cleaning to business lending and room sharing. The whole point of applying tech to these industries is that the businesses can be operationally lean and cheaper to scale – so huge injections of equity finance are often unnecessary.
To all tech entrepreneurs, I’d say think carefully before you give up a big slice of your business. A lump sum investment isn’t the only way to back your idea. Look carefully at your model and consider all the options. If you must take on investors – know how you’re going to spend every penny in advance. There’s no point in raising millions if you can’t spend it. It’s about burning that fuel in the most efficient, productive way possible.