The Cost To Grow Faster (Equity)
I’ve always thought of a “small business” as one in a more traditional industry that uses conventional financing (or no financing) to get started. All “startups” begin life as a small business but the way we think of startups today, they’re looking to do something innovative and since most innovations are deterministic, they’re looking to accelerate growth before someone else goes to market with a similar idea. That requires leveraging equity from outside investors who put money into the idea, and the perceived capabilities of the organization to execute on the idea, in exchange for a part of the company. By contrast, the traditional small business is often ok moving slower but with a less dilutive means of capitalization.
On a larger scale, the stock market allows us to invest capital into an organization and receive quarterly dividends, sharing in the success of the companies we choose to invest in. During bull markets, or times when the market is doing well, share prices increase and investors can grow wealth. But at the heart of it, investing in companies funds innovative business models, technological advances, and people.
Venture capital works similarly. The money funds innovation and getting products to markets faster, outgrowing new industries, and establishing market share. It’s riskier dealing with startups than with public markets or traditional financing so the rewards can be greater. And most venture capital firms make investments into a number of companies in order to increase the odds they receive a return. For example, Y Combinator can boast early investments into Airbnb, DoorDash, Gusto, Reddit, Stripe, Dropbox, Instacart, Twitch, Coinbase, and Zapier. But it took investing in 2,500 companies to get there. Other similar organizations like TechStars and specialized incubators and accelerators in every city (and sometimes section of a city) are fueling innovation at a pace we've never seen before.
Nearly every company who makes it to massive success and goes public will give up equity in exchange for the funds and know-how to accelerate growth. Not all, but many. Startups also often provide equity to board members who can help the cause in other ways, such as contacts, publicity, and business advice. That last part is important because most of us don’t know how to scale sales, marketing, and finance teams.
We do need to be careful who we accept money from and how. As we take on “rounds” of equity we start to give up varying degrees of control in a company. Others own a percentage and can exercise those rights in meaningful ways. Investors who aren’t a great match for a startup can create a combative work experience, so make sure to get on the same page with what the investor wants out of the investment (other than to make 10 times their investment tomorrow).
In a bull economy where interest rates are low, there are a lot of places to put investment money to work. Founders that have a shipping product that’s netting a positive return will find it easy to raise funds to accelerate growth. Those with products shipping that haven’t found a good fit in the market or incomplete products may have to work harder, but there’s still a good chance some investors will take a risk. Many begin with friends and family and then move on to the “angel” community and then venture capital beyond that. We cover raising money further in Chapter 17 because in the beginning, we typically find that we prefer startups raise money from the most telling and least dilutive source around: customers.
Again, raising money through selling product both proves a hypothesis (that the innovation the founders are supporting with a company is valid). For that, we’ll need a product and to improve our capabilities with product design and product management, which we cover in further detail in Chapter 4.