I’ve had the fortunate experience to work with a wide variety of entrepreneurs in many different industries. Although all of them individually are different, they all have one common smilarity: They’re all usually raising capital.
Raising capital is often time fundamental to the survival of an early stage company; especially for the ones that are growing rapidly. However, I’ve noticed a phenomenon with early stage companies that has me a bit perplexed. It seems as though companies that have had a little bit of early success (i.e. revenue, customer acquisition, patents obtained, etc) seem to have a harder time raising capital than companies that haven’t yet achieved anything measurable. I’m going to dive into a few reasons for why I think this is the case.
Pre-Revenue Companies aren’t Judged That Hard
It is my thought that pre-revenue companies aren’t judged nearly as hard as companies that have achieved something measurable. When a company is pre-revenue, investors (especially angel investors) are allowed to dream about how big the company could get and (with a little luck) they may strike it big. On the contrary, companies that have revenue tend to be judged harder because investors have something ‘tangible’ to examine. When investors look at a year or two of financials they are able to point out flaws and start asking incriminating questions that entrepreneurs must answer or they run the risk of looking incompetent.
I’ve seen investors pick apart an early stage company because they wanted them to reduce their shipping costs. The entrepreneur’s response, “Our shipping costs will significantly reduce once we reach scale and by using the money from this round to build additional capacity.” Investor’s response, “Well, even though you’re making money, I think your costs are too high and I don’t think I want you to use my money to do that.” In most cases, I have witnessed many pre-revenue companies get the benefit of the doubt because at their stage, there is not really much to examine, except maybe some inflated financial projections and an endless stream of other incoherent and meaningless anecdotes that at the end of the day are absolutely worthless.
I was once speaking with an entrepreneur in the valley and he told me that before his company was making money, he and his business partner found it so easy to raise capital from investors. However, after their company achieved incremental success he said that investors weren’t as keen on him as they were before. My thought is investors look at an early stage, pre-revenue company and say, “this could be a homerun if it works.” However, if after a couple of years the company isn’t experiencing explosive growth then investors begin to think the company might limp along and eventually vanish into the ether of failed start-ups.
I’ll close with this – I think that once a company has moved beyond the proof-of-concept phase and has taken a strong position in a market (and has revenue to prove it) it should not be judged harsher than a company that has no revenue, no market share, etc. It just seems backwards to me.