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Venture Capital: the gap between investor rhetoric and reality

The heavy concentration of wealth in private hands, ideological biases against state funding and the preference for corporate investment based on short-term criteria tends to highlight the importance of private funding. In reality, most funding and investment is typically driven by a mix of public and private sources.

Public and Private funding can be provided in different forms: grants, loans, payments for products and services, and as equity funding. Companies can raise one or more types, depending on the specific conditions and constraints.

Companies can typically turn to 15 different sources funding, including banks, angels, venture capital, private equity, public markets, and large corporations, depending on the maturity of their propositions. The funding criteria are directly related to challenges of crossing the three Chasms described in the Triple Chasm Model:

  • when crossing Chasm I, most companies can access public grant funding augmented by private marched funding;

  • around Chasm III, there are many viable options, including customer funding, public markets and bank loans;

  • the biggest funding challenge is almost always around Chasm II, where the perceived risk in the highest. The problem is that the gap between investor rhetoric and the reality is highest at this point.

It is worth looking at Venture Capital in particular, because it claims to be designed to tackle this challenge explicitly:

  • Venture Capital makes very strong claims about how it likes to invest at this high-risk point in the investment cycle, based on the idea of looking at high risk-high return opportunities

  • Indeed, this commitment is articulated by a detailed model of different investment types, described as Seed, Series A, Series B, and Series C funding, usually segmented on the basis of the amount of funding involved

  • However, this does not always reflect the actual risk profile of a business based on maturity-but is more aligned with how the VCs perceive their segmentation based on amounts of funding

  • Critically, although venture capital says it operates at the highest point in the risk profile, for any company, attracting Series A funding typically depends on having already made good progress in crossing Chasm II - hence a typical VC term sheet will demand evidence of charter customers and a proven business model!

  • This gap between the rhetoric and reality is confirmed by the statistics: in our data-driven global research involving over 3,000 companies, we found that less than 3% of companies had managed to raise VC funding; and other studies also confirm this low success rate for companies when trying to raise Venture Capital funding.

  • What this means is that the majority of companies trying to raise VC funding to cross Chasm II are likely to be disappointed, unless they are active in an area which is fashionable amongst investors (for example, all those involved in artificial intelligence right now)

So where does this leave the majority of companies trying to cross Chasm II, which is the key to building a business which can scale?

Our research shows that companies crossing Chasm II may find it more rewarding to look at their customers (and sometimes corporate partners) for funding – customer revenues have the added benefit of improving the focus on the precise shape of the product or service.

Companies need to be sceptical of the current obsession with seeing successful funding by VCs as a measure of progress – the amount of funding raised and the associated valuation of the company (almost always based on private deals not tested in the ‘real’ market) are a poor guide to real progress, unless your objective is to sell out well before you get to this point. The problem of course is that many investors, policy-makers, intervention agencies, and commentators constantly reinforce this idea - but not everyone can emulate the success of Facebook!

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