The figure at right shows a typical successful company’s growth in value. Highlighted on this curve are when capital is readily available.
Venture capital is most commonly available for early stage companies – those generating less than $5M in revenue. This is the high risk stage of company development, with a 70% 10 year failure rate.
Companies need the money because they are not profitable so VCs are able to secure favorable valuations. This dynamic of “invest a lot of money at low valuations” is fundamental to the VC business model.
After the company has grown rapidly and gotten almost to maximal scale, the later stage capital providers are out in force. Private equity wants to get in earlier than debt so that it can catch more of the value creation curve. This is typically when companies generate >$15M in revenue or >$3-$5M in EBITDA.
Private/mezzanine debt providers like having private equity firms in before them – they act as another layer of risk mitigation against default. Commercial banks are really only available to provide loans when there is little to no risk in the business. They often like to do deals with “sub-debt” (debt that is subordinated to the bank) providers, because they act as a layer of risk mitigation.
The Capital Gap
The obvious gap in this cycle is when the company is creating most of its value. During this high growth period, no capital is available to them. More accurately, during this stage capital is available… but undesirable.
Companies can certainly get VC, but they have to lower their valuation expectations to fit the VC business model. Doing this is particularly distasteful to entrepreneurs who can see the massive value they are about to create, yet are asked to go backwards in valuation.
Such companies can also certainly get PE, and maybe at an acceptable valuation, but they have to take more money than they want or need, resulting in comparable dilution. Such transactions also more likely involve a required change of control (ie selling more than half their business) or distasteful fees and conditions.
And of course, such companies can certainly go to a bank, but they have to mitigate risk for such lenders through personal guarantees, which is often incompatible with owners’ risk tolerance or sense of common sense fairness.
This is the gap that Polus addresses – give companies who deserve it the capital to create value, and leave them with the equity so they can realize the fruits of their labor.