Children Believe In Unicorns. Investors Believe In Racehorses
When investing in startups, you need more than your gut feeling to place a good bet.
It seems that facts and data are sometimes left by the wayside when making important investment decisions. Founders weave fantastical stories and visions of the future they want to build, and investors will throw buckets of cash at their companies for a spot on their cap tables.
But numbers don’t lie.
Investing in startups can be a risky business. And you need more than your gut feeling to place a good bet. Because at the end of the day, you shouldn’t be investing in heartwarming stories or tall tales.
You should be betting on the companies based on the evidence of the value they can provide. With revenue-based financing (RBF), you not only make a more sound investment, but you also increase your chances of investing in multiple winners.
Train Multiple Racehorses Instead of Chasing One Unicorn
Traditional VCs are constantly looking for one company that will make back their losses (and then some). Unless they have an exorbitant amount of cash, that’s an extremely challenging business model to have.
It also means that founders may chase a billion-dollar valuation at any cost, setting themselves up for failure.
RBF is a win-win for investors as well as founders. Founders receive the capital injection they need to continue scaling, and investors receive a consistent return on their principal. And, much like traditional venture capital, investors can also maintain equity in the company.
But with that consistent return of capital, RBF funds (like Capital Mills) can continue to re-invest either into the same businesses or into other companies to expand the portfolio. In other words, RBF does a much better job of generating returns and building on the principal investment, whereas traditional VC keeps those funds locked up in a handful of startups for years. As Toptal found in their report Revenue-Based Financing in VC: A Study on Playing Averages Over Home Runs, capital recycling offers more opportunities at any given time when deploying RBF.
And when you’re building a team for the long run, you want as many winning racehorses as possible.
Overfeeding a Racehorse Doesn’t Make It a Unicorn
When a business is struggling, one of the first excuses they’ll come up with is “we need more money.” Even if it’s not struggling, companies seem to raise rounds just because they can.
But haven’t we learned in our business school classes that any growth higher than 50% poses serious risks for the continuity of the company? This percentage may be considered old school, but even growth guru Verne Harnish warns against certain fast-growth strategies.
And even after looking at decades of research about business development, our common sense plays an important role as well. A team that grows from 30 to 100 over the course of 12 months is unlikely to maintain a healthy culture or drive at such a rate. Plus, management can’t possibly grow a quality business and overcome new challenges in that kind of environment.
Growth for the sake of growth doesn’t make a company successful.
For every racehorse that reaches unicorn status, 9 racehorses find themselves left with a wrecked capable or breakup of the company. It doesn’t have to be this way. Founders (and investors) should instead focus on the fundamentals that can lead the company to success.
How to Properly Support a Winning Racehorse
Sometimes founders are just stuck. They hit a plateau that isn’t quite a failure, but it isn’t growth either. And a quick injection of funds can give the company the extra push it needs.
When seeking that game-changing capital, a company should already generate revenue and have a clear path forward. They need to demonstrate that they know how to put the capital to good use and expect to grow throughout the investment.
This may seem like an obvious statement, but founders need to demonstrate why they are a sound investment considering how many startups don’t succeed.
For example, in the early stages of Mopinion’s growth, they wanted to invest more into sales and marketing. As news of Mopinion’s personalized service and affordable prices spread, more and more companies wanted to use their platform to improve customer service. Mopinion was on the upward path to growth, but they didn’t have the capital to expand their team.
Capital Mills saw and understood their trajectory and offered them RBF and support with business development and recruitment. Today, Mopinion continues to help its clients collect and incorporate customer feedback into their products. And they didn’t need to sacrifice equity or cut corners to grow successfully.
The beauty of this concept is that it allows for scaling up with bigger rounds at the right time. Invest when the company has proven its scalable business model. Most markets mature in 10+ years, so even if a company needs to break from the pack, it can take a few years to do this.
Conclusion
There is no way to guarantee which companies will succeed. But when founders can demonstrate a thoughtful strategy and promising revenue stream, they’re already ahead of the curve.
RBF is a great option for founders who know what they need and have a clear vision of reaching their next milestone. When we at Capital Mills invest in a company, it’s an acknowledgment of how well the founder is doing and the steadfast belief that the founder will continue to be successful with additional capital.
Yes, it still requires a bit of faith, but as an investor, I’d rather bet on a proven strategy than a wild unicorn chase.
