The Funding Black Hole: A Call for Innovation
There is a funding black hole. It sucks in and destroys the gross majority of startups worldwide. It may have even frustrated more innovation, economic development and human progress than all of history’s wars, diseases and natural disasters combined. This “black hole” is the global gap in startup funding.
Small Capital Needs
Startup funding exists at the smallest levels, either through microfinance (averaging less than $400 per loan), friends, family, small business loans, government assistance or personal wealth. While an encouraging beginning, none of these capital sources scale well (unless one happens to be already rich or flush with wealthy loved ones). Loans are particularly burdensome for entrepreneurs, with microfinance being onerous at larger amounts.
Large Capital Needs
The next level of significant startup funding is via equity investment. Angel investors often provide equity investments for startups needing between $25,000 – $750,000 ($USD), with a 2008 average invested amount of around $275,000 by Angel groups in the US.[i] The next level of funding is through institutional venture capital firms, who average around $5 million per deal.[ii]
While a partial solution, Angel and VC capital has thus far proven unattainable for the gross majority of startups; not because of the amount of funding desired, but because of the astronomic growth and high exit potential needed to attract this funding in the first place.
To attract equity investment, startups must promise at least 11-fold returns over seven years (or 20-50% average annual returns) with dramatic acquisitions or IPOs. They must be a “home run,” with no points given for a “double or a single.” A Kaufman study of the Inc 500 fastest growing firms in the US between 1997 – 2007 found that only 16% received institutional venture capital investment[iii].
The Black Hole
This black hole between diametrically small and large opportunities devours the majority of promising startups. More than 99% of all employer firms in the US are small and startup businesses (employing more than half of all private sector employees), of which more than 50% fail every five years.[iv] It is worth repeating – roughly half of US employer firms fail every 5 years. In corporate terms, that is enormous turnover with profound consequences for economies, families and reliant business partners of every manner. Many businesses fail on their own accord, often deservedly so. However there are profound benefits to be realized from getting the numerous other, sound, high-potential startups the capital that could maximize their impact.
Who will fill the gap? What proverbial cork will stop up the black hole? Who will provide those genuinely deserving startups the funding needed to transform markets, economies and lives? This is not a call for charity or shoddy investments, it is a call for innovation. The black hole has been called out. Startups everywhere wait for an answer – for financial innovation – to whisper back from the abyss.
Thomas Thurston, President, Growth Science International, LLC,
Mark Streich, Founder, Surxel Venture Advisors
[i] Angel Capital Association, ACA Member Landscape – 2009 Different Than 2008 (And Not), (April 16, 2009)
[ii] Chachere, Peterson & Mendell, National Venture Capital Association & PriceWaterhouseCoopers, Venture Capital Investing Has Modest Start in 2010, Amidst Economic and Market Uncertainty, (April 16, 2010)
[iii] “Right-Sizing the U.S. Venture Capital Industry,” Paul Kedrosky, Ewing Marion Kauffman Foundation, June 10, 2009 (http://www.kauffman.org/uploadedFiles/USVentCap061009r1.pdf) (Accessed June 12, 2010)
[iv] U.S. SBA Office of Advocacy FAQ 2009 (www.sba.gov/advo/stats/sbfaq.pdf) (Accessed June 12, 2010)
THANK YOU! If we demanded financial innovation the same way we demanded technical innovation, this would be a different (better) world. Not the kind that got Wall Street in a huge mess, but the kind that helps good businesses survive. Microfinance did that for really, really small businesses. What about the rest of us???
Where I work the CEO spends so much time trying to raise money that she doesn’t have as much attention for the business. While it’s working, it would be much better if there was access to money so that the CEO could spend as much time and effort actually running the business. We’re bootstrapping for the most part, and about 25% of our budget is spent on travel or prep in order to try and get funding. That’s a huge problem I wish there was a better way around. Wish I knew more rich people
While lack of funding devours many businesses, the battle to get funding is also part of the proving ground for companies. If the business is very good, and the founders are reasonable and competent, they can usually get funding. For businesses which are not so promising, or with founders who lack the right skills and experience, it’s good to have a rigorous filtering mechanism. That’s hard on the good companies, who would certainly like an easier route to funding, but is necessary to filter out the poor investments. In my experience, investors are hungry for good investments, but even if there were billions of dollars more available, they’d still expect founders to prove their case…even if it takes months. Often the founders who complain that funding takes forever have unrealistically high valuation expectations, and won’t adjust to what the investors will pay. So they spend years touting their companies until they’re worth nothing.
This funding problem is particularly the case in most of Asia, Latin America, and other countries outside the US where the problem is far, far worse. The US and even EU have it much easier than anywhere else I’ve experienced. At least there IS an equity market for startups in the US, even if it’s not solving the entire problem. Other countries have virtually no equity market OR debt market for small businesses. Unless you have a rich “uncle” somewhere you’re virtually out of luck.
Thinking about the mechanism of seeking funding, Mr Evans is correct – there is a gantlet requiring persistence, retooling pitches, self-evaluation, etc but for the venture it ends up creating spin to match the latest whims of the faintly informed comments by investors. Much of it is a “wrong, try again” process without really constructive comments on what isn’t ‘right’ about the opportunity.
Perhaps what is needed is a shift in pitch and due diligence methods. For example, investors are generally making the first snap decision after a 5, 8, or 10 minute pitch with some questions. The delivery, the slide deck, etc all have to be done well since even a great idea can’t overcome a poor presentation. In my exposure to screening committees, etc there seems to be something lost in the dynamics of a less formal pitch in front of 8-10 people and a pitch in a room of 100 people. The angel events are more like an auction block where the crowd mood can turn and there is little real interaction.
I don’t have a clear solution but I’ve been through screenings where the committee obviously never read a jot of the business summary, and others where they were prepared with good, challengine, insightful questions.
I wonder if a single pitch event with everyone in one room, while convenient, could better be served by having several rooms and rotating pitches. For example, take 100 investors and 20 ventures. Normally that would be one big room, 8 minute pitches plus 2 minutes Q&A, total of 200 minutes plus transition and breaks. Take that same scenario but place investors in groups of 10 in rooms listening to five 10 minute pitches (8 minute pitch plus 2 minute Q&A) per session. The ventures give their pitch 10 times. Same total amount of face time for investors but a more intimate Q&A, avoiding the ‘big room’ hesitancy on asking really interesting questions. Its likely most rooms will get lively and be more informative. To really make it valuable to the ventures, extend the period to 15 minutes overall, any mix of pitch and Q&A.
Finally, I think a step between pitch and due diligence is needed that is more like tire-kicking. Allowing investors to start looking at a company more closely so they can make specific critiques to help a venture but from a position of more knowledge beyond the pitch.
Yes, I think a lot of companies that don’t get VC money don’t deserve it. Sort of startup darwinism. However, a lot of fantastic companies never get VC money either, and I think this is what is needed in the way of innovation and a call to action. How to get money to the GOOD startups (not the duds) that can’t get it today. Off the top of my head I can think of 4-5 startups here in Boston that have grown around 25-40% a year for a decade with great revenue and profits that still can’t get VCs to take them seriously because nobody sees a likely “exit.” Also, they’re not growing 300% a year, so that’s held against them. Still, great businesses. How can they get funding? It will have to be some new approach, especially since bank loans suck.
I keep thinking the format of the Angel Funding pitch events isn’t quite right. Its sort of a speed dating event in the hopes that the pitch catches attention and the investors will follow-up later. Variations such as the Kieretsu Forum seem to be more productive. Another approach is to create seed-stage funds from the angel groups, sort of a mutual funding method with a moderate due-diligence threshold (like the screening committee). I understand a Vancouver BC Angel group does have a ‘mutual fund’ approach so smaller investors can pool resources but its still aimed at the angel-level company. The higher risk seed-stage is still left to fend for themselves.
Interesting thoughts Michael. I believe Kieretsu does both a good job at helping angels and startups preview deals, in addition to letting angels pool funds into deals as a group.
This is especially problematic in my community – Detroit. There are a respectable number of ambitions trying to do good work here and really make an impact. Many of these have been small businesses in the community, small with big goals, many of which have bootstrapped impressive growth, but stop dead in their tracks trying to attract the next level of intelligent capital.