“It takes money to make money” applies to start-up and early stage enterprises as much and more than to other businesses—large or small. From “day one” start-up and early-stage entrepreneurs risk falling into “the valley of death” if they do not secure adequate funds to cover negative net cash flow in their early months and years of new business creation and growth.
The “valley of death” is a deep and wide gulf of money supply and demand in the marketplace for young and unproven enterprises. Years ago, this author coined the phrase “entrepreneurial capital gap” and illustrated it with a two-dimensional chart that suggests the “valley” is actually closer in dimension to a “grand canyon” of need vs. availability (or lack thereof) of investment capital for entrepreneurs. The canyon’s depth signifies the amount of money required, and its width signifies the difference between what entrepreneurs are able to raise from founders, friends, and family and what is available from the formal venture capital industry.
Today the canyon’s depth for technology entrepreneurs is from $500,000 to $1,000,000 or more. Its width ranges from $2,000,000 to $10,000,000, dictated by the minimum investment that VC firms prefer to invest to match their costs of management. Back in the 1980s the capital gap width was narrower, only $250,000 to $500,000. But since then VC firms have matured, now usually raising and managing larger pools in the range of hundreds of millions of dollars. And with this change they no longer expend the time and funds needed to manage small investments; rather, they look to fund and manage a small number of multi-million dollar investments. Further, they typically find those investments to be with companies already with innovative products selling into the marketplace, not start-up companies still in the R&D or market-entry stage of evolution.
As a consequence early-stage entrepreneurs find that their sources of money, founders, friends, and family, move them forward only to the canyon’s “south” precipice, at which point they are peering down into the “valley of death.” Some are able to secure “angel” investors, keeping them from falling into the canyon by narrowing the canyon width a small amount. But angels are helpful only if they have alignments with VCs willing to make the follow-on investments that can finally bridge the remaining capital gap.
Some states have put in place small seed and early-stage investment funds to help address the entrepreneurial capital gap, but many can not decide whether the investment goal is pure job creation or cash return on investment. As a result, state legislatures keep changing the management and/or strategy of their investment program, or terminate the programs altogether. In the 1980s and 1990s state programs started on the path to become a significant force in narrowing the entrepreneurial capital gap, but now most have minimal or negligible impact on the shortage of start-up and early-stage investment funds.
The “valley of death” remains wide and deep and many young companies continue to fall into the gap or linger near death. Hence, many innovations never enter the marketplace and many new jobs never get created!
* NOTE: Text Copyright 2006 by Dr. R.T. Meyer