Do you have revenues of $5-$10MM and profits under $3MM a year? Are you a company looking to raise outside capital for the first time? If you answered yes to both of the preceding questions, you are about to enter what I call “The Death Zone” for venture capital. ”The Death Zone,” named after the oxygen-starved environments more than 26,000 feet in elevation, can make for a suffocating experience when trying to raise capital.
Why is this called “The Death Zone?” It is because businesses of this size have typically grown beyond the size where early-stage venture capitalists like to get involved but have not grown large enough in size to get the later-stage private equity firms excited.
To add to the complexity here, venture capital investors are typically looking for very different characteristics than private equity investors in terms of the types of companies and management teams they look to invest in. Venture capital firms prefer rapid growth even at the expense of profits and private equity firms much prefer stability in your annual cash flow stream, as they will most likely add a layer of debt to your business (to save them from having to invest additional equity). Therefore they will need a stable and predictable future cash flow stream with which you can pay interest and future principal payments on the debt.
That said, there is some potential good news for you. If you are a high-growth tech startup that still desires fast-growth minded venture capital investors, once you get to $10MM in revenues, you will actually open up a large base of Silicon Valley venture capital firms (each with billions of dollars in capital under management) that won’t even look at your business until you get to $10MM in revenues.
What does this all mean to you entrepreneurs? It means one of a few things: (i) If you are looking for rapid growth capital from typical VC’s, make sure you approach those investors well before your business gets to $5MM in revenues; (ii) if your business is already in the $5-$10MM revenue range, just know you will be looking for a “needle in a haystack” investor, and allow extra time to source investors (most likely from atypical sources); and (iii) if your business is over $10MM in revenues, be prepared for: (a) cash-flow driven private equity investors which most likely means slower revenue growth; or (b) you are a tech business looking to continue rapid growth, and will be lucky enough to appeal to the big Silicon Valley venture firms.
With this newfound information about the nuances within the financing world, grab your ice axes and crampons and hopefully you will get to the summit—in the form of a closed financing.
This article was originally published on RedRocket VC, a consulting and financial advisory firm with expertise in serving the start-up, digital and venture community.