Not all startup funding the same

Our small family office has funded thousands of companies and billions of dollars in the last 32 plus years.

Yes we have funded and continue to fund startups. No, we don't fund typical startups and we don't fund typically.

We fund business-to-business (B2B) companies that have at least gotten to revenue.

Let me give you an example of funding that isn't a VC fund raising money to invest as little as they can and get a good post-money valuation on a company that now has to race at company crushing speeds to "unicorn" or a billion dollar valuation and IPO exit. That is all we hear about in the news. No, that isn't the only way a startup can get funded.

The modern, late to the game, current venture capital model isn't the only way to fund startups. The definition of startup has been and continues to be much broader than that narrow definition.

Would I start a company and raise venture capital money if it were up to me? No, I don't like that model. It is bad for the founders. It doesn't raise up new leaders. It is like rookie ball players getting paid more than they have ever seen except in the venture world the founders are just getting paid in fame and hope and not getting the big dollars. It still has the same devastating affect on most founders. Either they fall into the temptations and over utilize credit and levers personally to live up to the hype, or they get disillusioned and fall out of the race paper rich but having worked way harder than they would have for 5 to 10 years with unsellable stock as all they got out of it. Yeah, they got experience, but let's be honest the "billionaire founder" status and the "lifestyle" were what drove them to sacrifice their youth.

The problem is that before 2008, before the financial crisis which started way before 2008, venture capital was something different. In fact, it has changed often. And, it isn't the only game. It has gotten much attention because of "socially loud" startup venture funds founded by college graduates who had no job prospects and raised investments for their startup called a fund promising investors that they would somehow throw money at 20 deal on $10 million raised (limited by 99 investors rule) and hope that one or two would go on to become the next "unicorn."

Now, let me give one example out of many of our successful startups. First let me define startup. The definition is different depending on whom you talk to. For this example, we are going back to the traditional definition of a new small business that has just started and has zero history but has its first client ready to go.

Before they were popular, IT services companies which sold on a flat rate for a monthly fee weren’t called managed service providers. This was the time of the break-fix and one job at a time IT services companies.

Four guys graduated from the University of Texas. In Texas, Aggies from Texas A&M take offense to that other university being called THE university of Texas since Texas A&M came first. But I digress. But, they had good references and believe it or not some of them were Aggies so that made up for it. You know what an Aggie is four years after graduation right? The boss. Sorry for the Aggie jokes.

Now, these four guys right after graduation decided to start an IT services company that took clients on a monthly fee and managed their desktops and networks and services and sometimes their phones too all for that monthly management fee. It was a novel ideal back then.

They came to us with their company established and one good client ready to go. They knew that if they didn’t have funds they would get stuck in the trap of not getting paid in time to make payroll and taxes. So, they came to us.

Now, it has been a long time, but this is what I remember.

They grew in 8 years from $0 to $25,000,000 and sold. During that time, they were too young for bank money at first, so they used us until they had much more revenue and absolutely had to go for growth venture money (different deal than today’s VCs) and like a Private Equity (PE) shop today the venture capital group raised funds from private investors to invest in this deal for a fee.

But, these guys knew we had their back so they were smart and figured out how to keep us in the “stack” as they say today so that we could continue to fund them without diluting the equity in the deal. They were able to exit the venture burn cycle early and buy out their venture backers in a shorter time than was planned. But, what VC backed deal today to you hear buying out their first VC round? Unheard of? It actually happens more often than you would believe. Why? Because it is always better to own the equity of your company especially during fast growth when you can. Why let VC stay in when you can buy them out?

Then, they continued to use us and grow fast until they went off to what is called “mezzanine finance” today. Never heard of this? There are many other ways to fund a company other than expensive equity deals with VCs.

The same thing happened. They kept us in and we were able to help them buy out mez money faster and they used us to grow until they sold the company.

Not the fastest startup success story we have, but this example proves there are other ways to fund startups.

“Why sell at $25,000,000 when they could have got VC money and exited at a $1BB valuation?” you ask?

What equity would the four founders own at the end of 8 years if they went the VC route?

10% maybe?

10% of $1BB in valuation is $100,000,000 on paper; not cash in the bank. Divide by four and they might own $25,000,000 each. Right? But, they only way they get access to that is if the $1BB company exits in say an IPO round. Now, they cannot sell all of their stock usually in the pre-IPO, right? So, maybe they got more in the VC round, but what did they trade for that? I guarantee it isn’t the same stress level owning a $25,000,000 company verses running a company running to $1BB in valuation that you only own 10% of, right? I am sure that they were getting paid as employees of that $1BB company if they got to stay with the company. Most venture groups would probably insist on a more seasoned executive team to raise the funds to get to the $1BB valuation, right?

Let’s say they kept half of the $6.25MM equal share of the $25,000,000 sale; the government gets their half right? So, walk away with $3.125MM each? Four guys 8 years out of college, what lifestyle do you choose?

$25MM in stock in a public company that will bear they ups and downs of the markets, or 25 years of $125,000 a year from putting your after tax dollars in an annuity or other insurance product that lets you live comfortably off that amount over time?

There are many options.

What larger investment is $125,000 as a return on at say 3%? So, $125,000 a year is like having that larger fund in the bank paying you interest for 25 years?

Some will choose the lime light and the glory of being the founder of a $1BB valuation company. If they are lucky, they will get a $350,000 salary as the CEO. And, maybe they will get invited to start funds and go on talk shows and write books.

Neither lifestyle is wrong. Just different.

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