Why Venture Capital May Not Be the Right Funding Choice For Most Early-Stage Startups

Venture capital (VC) has long been viewed as the ultimate source of financing for startups, but according to Jay Wilson, investment director at U.K.-based investment firm AlbionVC, it couldn’t be further from the truth.

“Venture capital is wrong for about 99% of businesses out there,” Wilson told PYMNTS in an interview, adding that “VC money is designed for very specific types of businesses with very specific types of ambition and in reality, it is a very expensive financing method.”

He added that venture capital is at the top of the capital spectrum from a risk-return standpoint, operating on the principle of outliers and Power Law Returns, which states that an investor makes all of their returns from a small number of businesses in the portfolio. 

And with a high cost of capital and double-digit rates of return required, some businesses, often because of structural reasons, cannot create value fast enough or grow into the global category-leading firms as expected in the VC space, he said.

However, startups have other options like venture debt, which he said has always been a useful addition to the capital spectrum. 

Ultimately, founders need to carefully consider their business and financing options before deciding on the best path forward, all while bearing in mind that finance is simply a means to an end. 

“It’s important for founders to think about what type of business opportunity they want to pursue. This is quite a critical part of the investment discussion at the early stage. Having decided on that, then financing is a secondary question to that,” he remarked. 

For example, at AlbionVC, which supports innovative startups in the FinTech and HealthTech sectors, Wilson said it has very little to do with metrics when evaluating startups at the early stage, be it at the seed level or early Series A. 

Instead, “it has everything to do with the ambition, mission, and vision of the founder, finding their uniqueness and the skill that they have as it relates to the problem that they’re ultimately trying to solve,” he said.

A New Layer of Orchestration

Wilson expressed optimism about the future of FinTech, particularly payments and financial services orchestration, which has been made possible by the emergence of new financial services through application programming interfaces (APIs). 

“Today, you can consume any financial service via API and that’s been net beneficial in the ability to bring products to market at lower unit economic cost, allowing the net new creation of financial services,” he said.

But with the proliferation of APIs, he noted that the bottlenecks are now around combining, managing, and orchestrating those APIs to deliver the end financial product required. 

So far, this has worked in payments orchestration as an industry category, but it’s now emerging in other sectors like banking, lending, and insurance as firms acknowledge that the underlying financial infrastructure is increasingly fragmented and commoditized and that there is a gap between that and the ability to bring products to market today.

Against this backdrop, Wilson said there is an opportunity for a new layer of orchestration to be created in the FinTech stack, including identity verification and treasury-related tasks such as cash management and foreign exchange risk management. 

Lastly, when it comes to the rise of artificial intelligence (AI), he said the development of large language models and their ability to drive operational efficiency holds promise for many industry verticals, including the early-stage investment ecosystem. 

And ultimately, all investment funds will need to adopt the technology in some form in the coming years to remain competitive: “We’re still a long way off from completely automating investment decision making but [AI can make a difference in] operational effectiveness and productivity in the first instance,” Wilson said.