Can my company obtain funding from a VC fund? The answer may be puzzling if we are unfamiliar with the context and the way funds operate.
First: your company offers no prospect of recouping the investment with a profit
Not every company should finance growth with venture capital. Rejection may reflect not only the quality of the team or product but also the fund's strategy, the project's stage, market size or expected returns. Without a stated sample and source, no single acceptance rate can reliably be given for the market as a whole.
Above all, the VC model assumes that most investments will yield no return; indeed, the fund accepts in advance the risk of losing the capital invested. The remaining investments must therefore offer at least the potential to cover those losses many times over. High scalability and exceptional profitability if the project succeeds are consequently crucial.
These requirements concentrate investment in markets where a new technology or business model can cause a real and rapid breakthrough, or 'disruption'. In this context, even a relatively healthy, profitable company that has lost its prospects for rapid growth is not a successful investment for a fund, but rather a 'zombie' ('living dead company') that would be better disposed of as quickly as possible.
Second: your product does not involve new technologies
According to the latest annual report of the National Venture Capital Association, using 2016 data, 898 venture capital firms operated in the US market, running 1,562 active funds with more than USD 333 billion in assets under management. Investment has a distinctive distribution by both sector and geography.
The vast majority of financial resources and investment projects are concentrated in just three states: California, with more than USD 181 billion in assets under management, Massachusetts and New York. Other centres are statistically almost irrelevant to the overall picture. In nearly a quarter of states, VC funds do not operate at all or investment is marginal.
By sector, investment in software, at 33%, and information and communications technologies dwarfs all others. The traditional exception is a specialist group of funds investing in biotechnology and medical technology. Businesses based on physical products face particular scrutiny, especially where product development and market launch take a long time.
In Europe and Asia, despite their particular local conditions, the situation is very similar: investment is highly concentrated geographically and by sector. It is observed that VC investors prefer to invest 'close to home'. This can be explained by the way investor networks develop over time through a self-reinforcing cycle of growth and reinvestment, as successful entrepreneurs become investors themselves and initiate a new phase of development (as we discussed previously).
Third: your company is an outsider
Although VC funds should theoretically seek projects capable of creating new markets — 'skating to where the puck is going' — herd behaviour and fashions for particular developments and technologies are powerful forces here, as elsewhere in capital markets. One example is the revival of interest in artificial intelligence after the long 'AI winter': http://dspace.mit.edu/handle/1721.1/80558. Projects that do not fit 'hot' themes have far less chance of attracting the spotlight and breaking through when attention is directed elsewhere. Fund 'me-tooism' is normal to a degree, but where the imbalance between the supply of projects and available capital is growing, it signals a crisis in the VC industry.
Likewise, excessive caution, signs of confusion and conformity among funds indicate harder times. As the history of the 1980s shows, when VC funds turn en masse towards traditional markets and low-tech businesses — retail, restaurant chains and clothing — or projects based on aggressive acquisitions rather than breakthrough innovation, they rarely achieve the intended result of more predictable investment returns (http://reactionwheel.net/2015/01/80s-vc.html).
VC funds — a solution that is not for everyone
The VC industry fulfils its role best when, with the right timing, it aligns with technological and social macrotrends to help a new business reality emerge faster and realise innovation's full potential. This perspective also makes clear that many founders should not consider this source of finance at all, even if it is offered. Accepting may be a bad idea for both parties because expectations and realities do not align.
Having examined several key general issues, we will explore building relationships with funds from the perspective of individual companies in further articles on this subject.
