Why Do So Many Entrepreneurs Want to Raise Capital?

I’ve been pondering the issue of equity financing for startups and early stage firms an awful lot lately. It started a few weeks ago when I discovered the following (all numbers are approximations or estimates from the sources noted):

  • 1,450 venture capital (VC) investments were made to seed/early stage firms in 2008 (National Venture Capital Association);
  • 24,750 angel capital (AC) investments were made were made to seed/early stage firms in 2008 (Center for Venture Research at University of New Hampshire);
  • 637,000 businesses were started in 2007, the most recent year for which data is available (U.S. Small Business Administration);
  • Of the nearly 27 million businesses in the U.S., 6 million have employees (besides the owner); the others have no employees (U.S. Small Business Administration)

New business starts in the U.S. dropped each year from 2005-2007, so I believe it’s reasonable to use the 2007 number as a conservative estimate for 2008. With that assumption, only about 4% of startup/seed/early stage firms (however you want to call them) received outside equity financing.

That was quite a surprising conclusion to me. 4%.

After all, we educators spend a good deal of time discussing angel and venture capital financing with our students. At the Coleman Center, like most entrepreneurship support organizations, we regularly get requests for help with raising angel capital. And virtually every program we have held over the years on the topics of raising capital, angel funding, and related subject matter has been well-attended, demonstrating strong market interest.

But this interest just doesn’t equate with the reality that few firms actually raise equity capital. Why? As much as I can tell, there are five reasons:

1. Raising capital has become glamorous. From the boom-boom days of the dot-coms, the mainstream and entrepreneurship press has applauded the maverick entrepreneur who raises gobs of money from salivating investors, sells the firm or goes public, and everyone goes home rich and happy. This attracts a whole slew of aspiring entrepreneurs who simply think that it’s easy, and cool, to raise money.

2. Most entrepreneurs don’t know why investors invest. While most investors hope that the firms they invest in get acquired or go public, the reality is that only about 1 in 10 actually do. And those that do are typically firms that have grown beyond $10-20 million in revenue, at the least. Firms that size require quite a few employees but the numbers tell us that 21 million firms in the U.S. don’t even have any employees beyond the owner. Unfortunately, based on anecdotal feedback, the vast majority of entrepreneurs seeking capital are these solo operators.

3. The risk-averse entrepreneur is emerging. It still surprises me how many first-time entrepreneurs say that they are not putting in any of their own capital into their ventures, even if they have some. In fact, many also expect their investors to pay their salaries in the first couple years. Unfortunately, too many learn the importance of “skin in the game” only after they’ve talked with investors.

4. It is assumed from the start that a venture needs outside capital. In projecting start-up costs, most entrepreneurs do research to uncover average salaries, occupancy expenses, and overhead costs. My experience is that too few apply creativity to minimize those costs, question the necessity of them, or align those costs with revenue projections. They simply take for granted that those expenses are necessary and that outside investors will underwrite them.

5. The entrepreneurs haven’t done their homework. One can argue that #’s 1 – 4 are a result of naiveté, ignorance, or lack of education. But it’s also evident to me that the aspiring entrepreneur hasn’t talked with established business owners to understand not only the funding process but also cash flow management. By doing that, s/he will quickly learn how most firms (the other 96% which haven’t raised capital) have started, operated and grown mostly on their own dime.

As a result of all this pondering I’ve been doing lately, I’m left with a few questions. How should we counsel entrepreneurs seeking angel or venture capital? What is the right balance in teaching bootstrapping vs. raising capital? How much do we follow market demand for this type of content vs. delivering the “real story”?

I’d love to hear your thoughts on these questions and your own perspectives on why so few firms raise equity capital in the U.S.

4 comments

  1. Pingback: Entrepreneurship Comes of Age at Chicago Universities | ramanations
  2. Pingback: Entrepreneurship Comes of Age at Chicago Universities | ramanations | smartentrepreneurship.com
  3. Pingback: smalescale-business-ideas.com » Blog Archive » Entrepreneurship Comes of Age at Chicago Universities | ramanations
  4. Pingback: If Raising Capital Is Taught, Why Isn’t Bootstrapping? | ramanations

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s