Fundraising isn’t as important to building startups as most founders think.

I was talking with an entrepreneur who’s running a successful services business. And by “successful” I mean it’s less than two years old, has four people operating it, and it’s already doing north of two million in revenue with a very healthy ~35% margin. Not bad, right?

However, it’s a true services company, meaning he and his team aren’t selling a specific product. Instead, every customer requires an entirely custom set of infrastructure and support.

I’m sharing these details because they’ll help make you as surprised by the question he asked me as I was: “We think it’s time to start talking with venture capitalists. What’s the best first step to take in order to start fundraising?”

“Fundraising?” I replied. “Why are you fundraising?”

“We’re doing a couple million in revenue,” he responded with a shrug, “and we’d like to keep growing, so it seems like the right time to fundraise. Everything I’ve read always says you should fundraise from a position of power, right?”

“That’s true,” I agreed, “But that’s not the only criteria to fundraise. You also have to be the right type of company.”

“What type of company is that?” he asked.

“The type of company that needs money,” I responded.

“But isn’t that us?” he responded. “We want to make more money.”

“That’s a common misconception,” I said, finally understanding the issue. “You think raising venture capital will help you make more money. That’s not what actually happens.”

A common misunderstanding about VC 🔗

When entrepreneurs read about venture capital, the process and outcomes are always described in the context of large tranches of cash. For example, you might read an article about how XYZ Startup raised a $5 million dollar seed round, or how ABC Mega Corp. took $2 billion in debt financing.

Whatever the case, the amounts of money VCs fund usually seem like large piles of cash. As-in Scrooge McDuck swimming through piles of gold coins amounts of money. But that’s not what entrepreneurs are actually getting when they raise venture capital.

Instead, when you learn that a company just took money from investors, you should assume the same company’s total expenses over the next 12–18 months will actually be significantly more than whatever amount of cash they just raised. In fact, it almost certainly has to be because that’s (usually) why companies raise venture capital.

When companies raise venture capital, they do so in order to continue paying their bills as they scale. As a result, you can assume the cost of scaling for the next 12–18 months is whatever their current revenue is plus however much money they raised.

In other words, the more money you hear about a company raising, the more money they’re spending. So if you read about a company raising a billion dollars — admittedly, a large amount of money to raise — it doesn’t mean that company has lots of money. It means the opposite. That company is expecting to be short nearly a billion dollars over the next 12–18 months. They’re not flush with cash. They’re hemorrhaging cash.

Don’t invent reasons to fundraise 🔗

I explained this relationship between fundraising totals and expenditures to the entrepreneur I was meeting with, then I asked, “Are you spending significantly more money than you’re currently making?”

“No,” he said. “We’ve got good profits.”

“That means you don’t need investment capital to operate,” I confirmed with him. “What about growing? Do you need investment capital in order to grow? Would VC help you scale?

“That’s something we’ve been thinking about,” he said. “We’ve been thinking maybe we could raise capital in order to buy out some of our competitors and roll them into our team.”

“That’s not a crazy reason to raise capital,” I conceded. “Raising capital to make strategic acquisitions is something companies sometimes do. Do you know what companies you want to acquire?”

“Not yet,” he said. “We haven’t started looking.”

“Then what kind of company might you acquire?” I asked. “What would you be looking for?”

“I don’t know,” he said as he flung out his hands. “I just thought that’s what startups are supposed to do. They’re supposed to fundraise and spend the money on stuff.”

“You don’t need to invent reasons to fundraise,” I told him. “Startups aren’t required to take venture capital. Startups should only take venture capital if they need venture capital. But you startups don’t need to raise money in order to be successful. In fact, the opposite is closer to the truth. Startups should try their hardest to be successful without taking VC.”

When to raise venture capital 🔗

The founder I was meeting with was struggling with a misconception lots of entrepreneurs have. They encounter so much press about fundraising and venture capital that they assume raising VC is a standard part of building startups. It seems as normal as eating ramen and working 15 hour days. But it’s not.

Despite the perception that every successful company in the world takes money from investors, that’s not actually the case. The vast majority of startups never take investor capital. The only reason people think the opposite is true is because the companies that raise lots of money also tend to be large, international companies that, due to their size, have plenty of visibility and get lots of press.

Don’t let all the press around venture capital and fundraising fool you into thinking it’s more necessary than it actually is. Venture capital isn’t a requirement for building successful startups. In fact, there’s only one good reason to take venture capital, and it’s this:

That’s it. That’s the only good reason to take venture capital. If you’re an entrepreneur already generating good profits without VC — or you’re on a path toward becoming one — you can scale by reinvesting your profits. In that case, why give away part of your company for something you don’t need? You’ve got a healthy business, and the only thing VC can do is screw it up.