What VCs think when startups they fund don’t spend their cash

Minnesota startup champion Graeme Thickins wrote a great blog post today about the seemingly large number of high profile MN startups that raise venture capital money they don’t ‘need’ citing companies like Code42, LeadPages and most recently Field Nation who raised capital after being bootstrapped for many years.

At the end of the post he posed a few questions about what VCs think when startups they fund don’t spend their cash.  I thought it was great approach as usually the questions are more geared towards the founders (‘why did you take the money if you didn’t need it’) than the VCs (‘how do you feel about your cash not being spent’).

Since the situation of a startup not spending their VC cash is super familiar to me I thought I’d take a stab at the questions, which are below.

Before getting to the answers, some additional context:  At Arthur Ventures we’ve made 15 investments out of our current fund.  3 of those 15 have not spent a penny of our money and another  3 have burned a relatively small amount (50% or less) before being roughly breakeven again.  All 6 of these companies have had at least a year since initial funding.

It doesn’t surprise me at all that we as a firm are incredibly pleased with how each of these businesses are performing.  So we love when this happens.

Now getting back to the questions:

  1. If revenue growth and profit trump everything, why do you need VC? (Truism: customer money is better than VC money.)
    • A few reasons float to the top:
      • Increasing appetite for risk: Clay Collins specifically has been very vocal about this.  Bootstrapping is great, but when you get north of 20 employees and you have $250K in the bank, it doesn’t take much for you to get into a cash pinch.  Combine that with trying to recruit folks to your company from out of state and/or stable businesses and you quickly start to realize the value of having multiple millions of dollars on the balance sheet.
      • You actually thought you’d burn the cash:  This has happened to us twice.  The company raised because they wanted to make material adds to the team (usually in sales), which would cause them to burn cash, but business just kept growing at a rate that outpaced their maximum hiring capacity.  Nice problem to have.
      • There is a secondary component to the raise: This has never happened in one of our first fundings, but often times when you see a big raise ($25M+) in a bootstrapped company, often times the founder(s) are taking the oppourtunity for some person liquidity in the raise. Even if it is less than 20% of the raise, it is life changing and well-deserved.
  2. Why do VCs deploy large sums of money that really just then….sits there?
    • Because all they care about is the growth rate of the business.  The question we ask our partner companies that haven’t touched the cash is ‘do you view capital as a constraint on your growth rate’.  If the answer is yes, often times its because they are a bit afraid to spend. In this case, we absolutely encourage them to spend the money.  However, the answer is almost always ‘no’.  The business is honestly doing everything they can to grow, they are just doing it in a profitable manner.  They are hiring at max capacity, they think their ad spend is fully optimized, etc.  This happens way more than you’d think.
  3. If founders aren’t asking for all this big money, is it flowing because VCs are pushing it on them?
    • I think there are two key reasons the founders take it:
      • #1 reason – because the terms are awesome.  Seriously.  If you are a rapidly growing, profitable startup that has reached material initial traction ($1M ARR and more) in a large market there it is very likely you get to raise on the terms you want.  That includes valuation, board structure, etc.  You call the shots.
      • #2 reason – you have built a strong rapport with the VC.  You aren’t going to take money when you don’t need unless the VC has a reputation for being a mature person, that has supported big businesses and is trustworthy.
  4. Does a startup take funds as a war chest for acquisitions?
    • Tough one to answer as it depends on the acquisition strategy.  If the company wants to do a lot of tuck ins (i.e, $5M or less total value deals with a mix of cash/stock) this can be done on a raise that is $25M+ of net cash to the company.  If the company wants to do one big one that will rely on a lot of cash, the raise usually needs to be $100M’ish to support that acquisition and still leave some for operations on the balance sheet.

I hope this helps provide a VC view into what we think of startups that don’t spend our money and what some of the motivation are.

Kudos to Graeme on a cool discussion topic.

get in touch: Arthur Ventures; patrick@arthurventures.com

5 Comments

  1. Wow, I wish I had that “problem” within my portfolio companies. A sophisticated entrepreneur may have heard the advice, “If the money is available, take it.” Similarly, having experienced fund raising and its enormous drain on time and energy, the entrepreneur may decide a longer runway has significant value. Pushing back the need for the next round and the ability to build real value in the company. Also, the entrepreneur may recognize that 6 months after closing and having a reserve available will let her sleep well at night rather than trying desperately to source funding to cover tomorrow’s payroll.

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