Under the Micro-Scope: The Rise of the Micro-Venture Financing

The early-stage financing conundrum is one that many entrepreneurs face. You need proof of concept to get seed financing, but you need seed financing to get proof of concept and a prototype/beta site. Many entrepreneurs turn to friends, family and savings to fund initial research, development and prototyping. Others, particularly those with previous successful start-up experience, rely on the help of state and local grants, private loans, angel investors and traditional venture capital. Yet, many potentially successful start-ups fail in this early stage because they lack funding sources.

Enter the micro-VC. Unlike angel investors, typical micro-VCs invest in dozens of companies a year rather than picking one or two on which to bet. Micro-VCs utilize smaller pools of capital than traditional VCs to make smaller investments in early-stage start-ups. They connect with start-ups very early in the project development process, and, as such, their initial cost basis is lower. Typical amounts range from $100,000 to $500,000, depending on the start-up’s business model. With smaller investments, many micro-VCs are happy with more modest absolute returns than traditional VC investors. One insider noted that most VC funds will not invest in companies without proven management teams or without an 80% likelihood of a $100 million+ exit. Micro-VCs still make good returns on transactions with valuations in the tens of millions, particularly when their original investments remain undiluted. Dozens of micro-VCs, including IA Venture Partners, Felicis, Tollman Capital, First Round Capital and Founder Collective, have emerged over the last couple of years. With the cost to start many types of businesses plummeting bootstrapping has become fashionable while credit has dried up.

Is partnering with a micro-VC an option for your company? As with most things, the answer depends on your business model. For cost-intensive business models such as life sciences and biotechnology, micro-VC probably does not provide sufficient capital, even at the upper range, to make such investments viable, since they are not sufficient to create working prototypes or solve many IP-related issues. Conversely, Internet and other IT/web models that require little physical infrastructure can thrive on such small amounts of money (and many thrive with less).

What are the positives and negatives of partnering with a micro-VC?

    • Positive: Flexibility. They give entrepreneurs flexibility when looking at Series A investors – the venture is not already affiliated with any one investor, meaning they can invite true bidding among different VCs if the venture looks promising.

 

    • Positive: Expectations. The meaning of “success” is smaller because smaller exits still mean big bucks for smaller investors

 

    • Positive: Efficiency. Micro-VCs condense the search for angel investors by aggregating the investment potential of many angels under one roof/management team.

 

    • Negative: Dilution. For rock-star concepts, micro-VC investors may make future investors less interested because their potential ownership stake may be diluted. Some investment analysts believe this problem will be solved as micro-VCs partner with larger firms on maturing investments.

 

    • Negative: Uncertainty. The micro-VC model has not been fully tested, and it is too soon to tell whether these firms, like good venture partners, will be good long-term partners. In addition, many micro-VCs will not invest in follow-up financing rounds which could limit financing alternatives.

 

This post on Company Financings was authored by Caitlin Vaughn.

 
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