VC isn’t for everyone: Finding the right funding path for your company

The allure of venture capital (VC) funding is strong in the startup world. Headlines abound with multi-million dollar rounds and eyewatering valuations for little more than a pitch deck. VC investment is often portrayed as the ultimate validation, the rocket fuel needed to achieve stratospheric success. But here's the thing: VC isn't the right fit for every company. Understanding what VCs are looking for, why their model operates the way it does, and what accepting their investment entails is critical before you chase that cheque.

What VCs are really shopping for: The high-risk, high-reward game

Venture capitalists are in the business of high-risk, high-return investments. They aren't looking for a small business that will grow steadily – they are searching for outliers, for companies with the potential to disrupt massive markets and deliver exceptional returns. And while they will take big risks, they will be looking for specific types of risk they feel qualified to evaluate.

All VCs will have: 

• A specific investment thesis – their "alpha": Most VCs operate with a core set of beliefs that guides their decisions. This is their anticipated edge, their reason for believing their portfolio will outperform the market. It could be a conviction that "software will eat the world" (as Marc Andreesson famously said in 2011), or a belief about a particular emerging technology like AI in a specific sector, or that a certain demographic shift is creating new market opportunities. This thesis dictates the types of companies they'll even consider. We’ve written about ZCC’s investment thesis in the past. VCs should make their investment thesis clear, however you could be forgiven for thinking a lot of them sound pretty similar. You might be able to get more nuance from their blogs, LinkedIn posts and interviews with General Partners. 
  

• A fund returns mandate – When VCs raise their fund from their investors (LPs), they will have promised a certain return level over a certain time period. As a general guide, funds will look to return a 3 or 4x multiple net of fees on invested capital (MOIC) over the lifetime of the fund, usually ten years. Depending on timing, this gives a healthy internal rate of return (IRR) around 20-30%, which is north of what one might reasonably expect to get from the stock market. This means that VCs need every company they invest in to have the potential to be a massive success – you will hear goals like the company valuation being over $1B (a ‘unicorn’), or the company returning 10x or more than their investment, or the company being a ‘fund returner’. Why? Because they understand a fundamental truth of early-stage investing: most of their portfolio companies won't make it, or will return little more than the initial investment (a 1 or 2x return). The successes need to be big enough to cover all the losses AND generate the overall fund returns. Data suggests that VCs might expect only one or two investments in a typical portfolio of 10-20 companies to be "home runs" (returning >10x). Several others might offer moderate success (2.5-5x), while a significant portion will only return the initial capital or fail entirely (Investopedia).
  

• A portfolio construction plan - this should go hand-in-hand with the investment thesis and the fund mandate, and will specify targets for how many companies the fund is planning to invest in each year, split by whatever parameters are relevant to their fund e.g. stage, sectors, geographies, types of founder, revenues, types of technology, business model.  

  
  

So, a VC has to decide if a company fits its investment thesis and its portfolio construction, AND has the potential to achieve a successful exit within the fund lifetime (as well as being led by a team they like the idea of working with for the next ten years). The typical VC sees around 1,000 companies a year and will only invest in a handful of them. For the market as a whole, fewer than 1% of startups receive VC funding (Forbes), and of those lucky few, around 30% fail (Exploding Topics).

Note: this data is for the US market, we believe they are representative of VC more broadly but would welcome more data points here.

Why the "Go big or go home" model? The maths of VC funds

This relentless pursuit of explosive growth isn't arbitrary. It's baked into the structure and economics of VC funds.

• The 10-year time horizon – VC funds typically have a lifespan of around 10 years (you might hear ‘10+2’ which means the fund can be extended by two years under the right conditions). Within this period, they need to invest their capital, help their portfolio companies grow, and then 'exit' those investments through an acquisition or IPO to return the capital to their own investors (Limited Partners, or LPs). You might think this time span doesn’t fit your market, and some funds do experiment with 12 or 15-year funds or an evergreen structure, however the majority of LPs favour a 10-year closed fund approach and this doesn’t look like its going to change. 
  

• Super-market returns – LPs (like pension funds, endowments, and wealthy individuals) invest in VCs expecting returns significantly higher than they could get from safer, more traditional assets like public stocks or bonds. This is because venture capital is inherently risky. To justify this risk and attract LPs, VCs must aim for outsized returns. This may be part of a blended approach by the LP e.g. they have the majority of their money in safer options and a portion for VC to boost average returns.  
  

• The maths dictates the strategy – If a VC aimed for a portfolio of companies with lower risk and more modest growth (e.g., trying to get ten companies to each return 4x), the overall fund return would likely not be high enough to be attractive in the competitive landscape of investment, because even some of those ‘safer’ companies will fail. The power law is at play, where a small number of investments generate the vast majority of returns. This is why VCs need those potential 10x, 50x, or even 100x outcomes to make the fund economics work. They need to compensate for the high failure rate inherent in early-stage ventures.

  
  

  

  Illustration of the power law curve from Horsley Bridge, an LP of Andreeson Horowitz. 6% of deals make 60% of venture returns, and half of deals lose money.

Taking VC money? Understand the implications.

Once you accept investment from a VC, you're signing up for a specific journey. Be prepared for:

• Pressure to grow fast – VCs will push for rapid scaling and significant market capture. Their success depends on your company becoming one of those big winners.
  

• A partner with specific expectations – If your vision is to build a sustainable, profitable lifestyle business, or a company with moderate, steady growth, a VC is likely not the best partner for you. Their goals (massive, quick returns) might conflict with yours which will lead to an unhappy partnership. 

  
  

• Dilution and board influence – You'll give up equity and likely a board seat, meaning you'll have less control.

  
  

• Commitment – your investors will expect you to be committed for the duration. You need to be super passionate about your idea, and committed to leading the company. There may come a time where you aren’t the right person to lead for many good reasons, but at the point of investment, the VCs are backing YOU as much as anything else in the company.  

  
  

These aren’t inherently bad things – for the right company with ambitions aligned with the VC model, it can be a powerful catalyst. But misalignment can lead to friction, frustration and failure. Make sure you talk with any potential investor early about these factors to check alignment.

Beyond financial returns – A spectrum of motivations

It's important to remember that purely financial 'generalist' VCs are just one type of investor. The equity investor landscape is diverse, with different profiles of risk, reward, and what I'll call ‘strategic returns’. Beyond financial ROI, many investors have additional criteria that might make them more interested in what you are doing - the 'z-axis' on their risk/reward graph.

• Impact Investors – These investors aim to achieve specific social or environmental benefits alongside financial returns (e.g. investing in clean energy, affordable healthcare, or sustainable agriculture). Look for specific impact measurement methodologies and minimum criteria. While some Impact investors are willing to accept concessionary financial returns to achieve the desired impact, this is usually not the case - in fact, some (like us at ZCC) believe that the impact will be the source of their competitive advantage and the driver for better financial returns (‘Profit because of purpose’).
  

• Corporate Venture Capital (CVCs) – Corporations may invest in startups for strategic reasons like gaining insights into new technologies, hedging against disruption in their core business, fostering innovation, or identifying potential acquisition targets.
  

• Regional funds – These usually have backing from public money and focus on fostering economic growth and job creation in a particular country or smaller geographic area.
  

  
  

Your Job: Finding the right fit and the right angle

1. Do your homework – Spend time understanding what different types of investors are looking for. Look at their mandates, past investments, and stated theses. Try and figure out what their likely ‘strategic return’ is - this might be stated clearly on their website, or you might be able to infer it from their LPs, fund structure, press releases, comments on social media etc.  

2. Be honest about your stage and risk – Assess your company's current traction, market size, and growth potential realistically. It’s hard to do this objectively, so you might benefit from getting an objective view from available mentors, advisors, industry experts, friendly investors at events etc.   

3. Ask directly – It’s OK to ask potential investors upfront about their expectations:

   • What types of risk are they comfortable underwriting? Some investors will never touch science risk. Some don’t feel qualified to look at certain business models. Some are ‘founder focussed’ and look for repeat entrepreneurs to reduce execution risk. 

   • What does a successful outcome look like for them? What return levels are they targeting? Over what timelines do they expect these returns? Do they want you to build a big, valuable company over time, or licence the tech as soon as possible and secure a quick trade sale? It’s important that your visions for the future of your company are aligned.  

   • What does their typical investment look like (cheque size, stage)?

   • Where are they in their fund deployment cycle? Are they currently deploying? 

   • What makes a company a great fit for their fund? What are their most common reasons for saying ‘no’? (This might flush out their strategic angle).  

4. Listen to feedback – If an investor says you're not a fit, try to understand why. It's valuable market feedback. You might disagree with their assessment, but it’s important to hear it - either they have got the wrong impression of you and your company (which you need to fix for the next conversation) or your value proposition isn’t as compelling as you think it is, at least for this particular investor.
   

5. Don't try to change their fund mandate – that’s not going to work. Instead, ask if they know other investors who would be a better fit.
   

6. Recognize that your profile evolves – As your company matures, your risk and reward profile will change, potentially bringing new investor groups into scope or ruling out others. If an investor says you are too early, ask them what specific milestones they would like to see to re-engage.

   
   

   

   Different funding sources available to companies at different stages of commercial maturity. The x-axis can also be seen as risk appetite of investor going from high risk (more catalytic capital) through to low risk/low return (PE). Source: British Business Bank/Innovate UK, published in the UK Government's Innovation Strategy 2021

   
   

Building a great company, with or without VC

There are other paths to funding which do not have the criteria and constraints of VC investment:

• Incubators and accelerators - provide great support to start a business as well as providing community. Many come with a cash injection, but usually in return for equity - check the terms carefully and watch for investment in-kind, make sure you are getting your money’s worth.   

• Grants and non-dilutive funding – look for government grants, industry-specific programs, or programmes and competitions that offer funding without taking equity.  

• Bootstrapping – many successful companies are built by reinvesting early revenues and maintaining tight control over finances. This route maximises capital efficiency and customer-funded growth. Be creative with how you can get potential customers involved early on - paid pilots, up-front deposits and joint development agreements are all ways to get revenue in.

• Angel investors and family offices – high-net-worth individuals and families who invest their own money at earlier stages. They may have more flexible return expectations or be motivated by mentorship. They will own some equity in your company, but are typically more relaxed about timelines and control compared to a VC, and they may have highly relevant experience and contacts.

• Personal loans – offer one way to get some cash to start a business. In the UK, Start-up loans are government-backed personal loans for individuals wanting to start or grow a business. 

  
  

• Commercial loans – if your capital requirement is modest and you have a clear path to revenue, traditional bank loans might be an option for your business, especially once you have some operating history. Try talking to a few providers to get a feel for their criteria.

  
  

• Equity crowdfunding – platforms like Crowdcube can be a way to raise money and can offer a way to build a community of supporters which may be relevant for you (companies like Brewdog and Monzo were successful with this route). Be careful though, the fees can add up, and this path may limit your options in the future - some companies find it hard to graduate off the platforms.

  
  

• Product crowdfunding (for consumer product companies) – platforms like Kickstarter can be a way to find early customers who are passionate about your product, to start selling, and get feedback.

The most critical factor in your funding journey is aligning your company's vision, growth trajectory, and your own entrepreneurial goals with the expectations and mandates of your investors. VC is a powerful tool for a specific type of high-growth company. For others, different funding options will be a much better match, leading to a more sustainable and fulfilling entrepreneurial journey.

Further resources for founders to navigate these choices:

• Understanding your business model & vision:

  • ‘The Lean Startup’ by Eric Ries – For iterating and finding product-market fit.

  • ‘Business Model Generation’ by Alexander Osterwalder & Yves Pigneur – The famous framework for mapping out and innovating your business model.
    

• Exploring funding options:

  • UK specific (many other countries will have their own versions of these)

    • As well as non-dilutive funding opportunities, InnovateUK has a division called Business Connect designed to support high-potential SMEs with business advice majoring on navigating finance options, with IUK Business Growth and IUK Scaleup. They have a handy list of different financing options.  Innovate UK also have a loans programme for later-stage R&D with high commercial potential.

    • The UK Business Angel Association has a directory of members which includes angel groups and some earlier-stage funds.

    • The EIS Association has a directory of EIS funds, which sometimes have more relaxed risk/return requirements compared to VCs.

    • The British Business Bank is dedicated to supporting small businesses - it has some great resources to explore different financing options. 

    • Local and national government business support websites – Often list grants and loan programs.

  • Climate specific - there are some excellent lists of resources out there, two of our favourites are:

    • CTVC’s mapping of investors (international) split into VCs, growth, infra and corporate investors. They’ve also just published a great guide to working capital options.

    • Climatescape has a huge database of climate backers, from angels to accelerators to private equity (international). 
      

• Understanding different types of financial support:

  • Investing platforms like Carta and AngelList – For insights into startup funding trends, angel investors, and VC activity (Carta Data has some fascinating research).

  • There are many educational resources about venture capital and financial markets more broadly – from the formal e.g. The CFA Institute, to the informal e.g. Investopedia.

  • The Global Impact Investing Network (GIIN) – Resources to understand impact investing.
    

• More about what VCs are looking for any why

  • McKinsey - the usual foundations of a VC-investable company

  • The maths behind a VC fund - Bryan Sanders