Fund Raising to Reduce Risk

In the spring of 2006, TeXchange hosted an event titled “Update on Texas-Based Venture Capital: The who, what, and why of VC activity in our region.” I had recently graduated with an Acton MBA in Entrepreneurship and attended the event to learn more about Venture Capital (VC) financing sources in Austin.

John Thornton, from Austin Ventures (AV), was one of the panelists, along with Bill Wood of Silverton Partners and Mark Heesen of National Venture Capital Association. The panel was informative and engaging with table discussion leaders from 12 different venture capital firms, but I felt that AV was the center of attention.

Austin Ventures completed 39 deals in 2006 (27 in Texas) and was in the process of closing the fund Austin Ventures IX at $525M. The most memorable quote of the evening was when John Thornton was asked about how much AV will typically invest in a startup. John’s answer, “what is the right investment amount to take out a majority of the risk” confused those in the audience looking for a general rule-of-thumb.

Raise the minimum amount of money to reduce the maximum amount of risk.

This concept of the minimum investment to reduce the maximum risk was something that I began to aspire to as I built financial models for startups in the process of raising money. I hoped I could one day present a forecast and strategy to Austin Ventures that would show how we were spending the minimum amount of money to reduce the maximum amount of risk facing the company. This included typical startup risks such as: is the product right, does the market exist, can we win customers, can we build a team, can we scale?

The discussion of risk is difficult and the metrics around quantifying risks are a challenge to create and measure. Often, the founders I worked with would short-cut the process or simply insist that such risks do not exist. To them the product is perfect, the market is huge (if not infinite), and every customer will want it, so sales will not be a problem. Entrepreneurs don’t tend to think in terms of risk. If they did, they would never start a company. Instead, discussions of how much money to raise tended to center around valuation: “what do you think the pre-money valuation will be” and “how much of the company are we willing to give up?”

Raise the maximum amount of money but give up a minimum amount of the company.

Since the TeXchange event in 2006, I unfortunately have not had an opportunity to pitch to Austin Ventures, and now that AV has decided not to raise another fund, it disappoints me to think that I probably never will.

On Wednesday, while talking with a venture capitalist who returned to a startup CFO role, I learned that in the past few years Limited Partners (LPs) have not wanted to invest in Texas funds. Instead, they prefer to invest on the East and West Coast.

On Thursday, the Wall Street Journal published an article titled “Meet the Hottest Tech Startups.” Of the 50 US companies in the Billion Dollar Startup Club, 32 are in Silicon Valley, 8 are in the Northeast, none are in Texas. Is it because the LPs have moved out of Texas?

Then on Friday, Dan Primack of Fortune magazine published his article, “The death of Austin Ventures.” What Austin insiders have known for a while was shared with the general public: AV has not been able to raise another fund. With any luck, John Thornton will stay active in Austin’s early-stage deals.

I still believe Austin is a great place to start a company. We have a very active angel network, great sources of talent, excellent schools, and a lower cost of living. Unfortunately, it may not be the best place to scale a company without local resources to finance Series B and C rounds – resources who can help entrepreneurs overcome risk and build a successful, billion dollar startup.

For me, I will keep identifying and overcoming risk to build great companies and hope that I don’t have to get on a plane to Boston or San Francisco in order to get the financial resources to scale.

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