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Should You Raise Funding for Capital-Intensive Businesses?

There is no easy answer to that question because there are many factors involved in reaching a conclusion on whether funding should be raised for a capital-intensive business.
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There is no easy answer to that question because there are many factors involved in reaching a conclusion on whether funding should be raised for a capital-intensive business.

What's Capital Intensive Actually Mean?

It's first important to determine what capital-intensive business really means. According to
, capital-intensive refers to "
a business process or an industry that requires large amounts of money and other financial resources to produce a good or service. A business is considered capital-intensive based on the ratio of the capital required to the amount of labor that is required.

Capital Intensive Industries

Typically, capital-intensive businesses are found in industries like oil, energy, transportation, and telecommunications. There is a significant amount of capital that must go into the production of the first product within these industries, but, once started, there may be economies of scale that can be gained that will eventually offset the capital intensity.

However, even other industries are finding it challenging to do more with less to roll out some of their products, including some of the hottest market segments today, including those new business models from the sharing economy and some IoT startups.

And, these startups are proving that it is possible to become successful even after starting off in a capital-intensive way because they are getting significant amounts of money.

The Good, The Bad, & The Ugly of Capital Intensity

Take Uber, for example, and other startups that are focused on a city-by-city expansion in order to leverage the most from its sharing economy business model, such as Lyft, Munchery, and SpotHero. Like other companies that have been designed around local deliveries across numerous, the logistics, labor, and overhead involved can quickly turn it into a capital-intensive endeavor.

Like Uber, companies are trying to accomplish this while being handed significant amounts of capital. Bloomberg noted startups like Good Eggs Inc., which received $2 million in April 2013, $8.5 million in September 2013, and then $21 million in September 2014.

Similarly, Uber has raised huge amounts of funding to the tune of $5 billion, but the company has also been valued at an extraordinary high amount now that it has a presence in close to 300 cities across 55 countries.

The good thing about this approach is that few competitors will want to take on this type of upfront costs, but the bad could be that the whole operation goes bust if the economy changes suddenly with considerable money lost in the process. It can be a huge gamble for an investor. Many investors still remember the failures of the late 1990s in the form of Webvan that tried a similar business model.

To counter that, these new versions of the same business model are attempting to do things differently by leveraging new logistics technology to apply a personalized business model to better align with each city they enter to yield those economies of scale that appear after the initial investment. So far, so good for many of these models, but recent news suggests the risk is truly real. At the start of August, TechCrunch shared the bad news from Good Eggs Inc. that their business model had cracks, resulting in the subsequent closure of all city operations outside of its first base of San Francisco as well as considerable layoffs added to the 15% workforce cut that the firm had made this past January. In explaining what happened, Co-founder and CEO Rob Spiro said, "The single biggest mistake we made was growing too quickly, to multiple cities, before fully figuring out the challenges of building an entirely new food supply chain. We were motivated by enthusiasm for our mission and eagerness to bring Good Eggs to more people. But the best of intentions were not enough to overcome the complexity. Today we realize that in order to continue innovating in San Francisco, our original market, in order to continue figuring out all the complexity that is required to achieve our mission, we cannot productively maintain operations in other cities."

Other industries are a concern as well. Cleantech is another area that is considered capital-intensive and has received significant funding. Yet, within this industry, there may be a different story about the need for capital-intensive businesses. Some investors are wondering if they should actually invest in something that requires that much capital.

An article from Green Biz noted some of the data that illustrates the uncertainty tied to getting involved in capital-intensive cleantech startups. While investment reached $6.3 billion during 2013, it sill showed a decline from previous years, showing the hesitation on the part of investors to get involved in this capital-intensive industry.

However, what followed were some positive signs in the form of a few successful IPOs and merger and acquisition activity but still challenges for many VCs to successfully exit from their investments in cleantech. It listed some IPO successes in 2013, including Silver Spring Networks (smart grid) and Control4 (energy efficiency).

Green Biz did note that investors were focused on: "those clean-tech companies operating in relatively low-capital sectors that can deliver rapid growth. It's a trend that potentially will leave start-ups working on ambitious and capital-intensive large-scale renewables and green infrastructure projects struggling to access the finance needed to bridge the so-called 'valley of death' between R&D and commercialization stages."

A more recent report from PWC from May 2015, entitled the Cleantech MoneyTree Report for the first quarter of 2105 illustrated some of the primary concerns with cleantech's capital intensity in the form of reduced funding. In the first quarter of 2015, funding decreased 72%, year over year, and decreased 75% compared to the fourth quarter of 2014. Additionally deal volume shrunk by 24% from the first quarter of 2014. Nearly half of funding went to smart grid and energy storage and to companies in Silicon Valley.

What to Consider Before Asking for a Lot of Funding

These two examples illustrate that it may not necessarily be a question of capital intensity, because many investors will still invest. Hence, the real issue is whether you have a viable "big idea" that can be turned into a sustainable, revenue-generating business.
You need to
about the following before you ask investors for significant amounts of money:
  • Is there any way I can reduce certain startup costs in order to be better positioned for using the capital I receive for the most intensive aspects?
  • What type of return will investors want on such a significant investment, and will I be able to deliver on that with a sustainable business?
  • Do I have the vision to convince investors that my company will be the game changer once past the initial capital intensity?
  • Does the market want my idea and is there enough interest to appeal to investors?
  • Have I generated any buzz or traction around my idea or business that shows investors the potential and opportunity?
  • Can I show any early validation in terms of revenue, customers, or both?
  • Do I have the team talent, knowledge, and intellectual property to carry this for the long-term to reach the necessary economies of scale?
Answer these questions well and you will know you should roll the dice and go big by pursuing large amounts of funding for your capital-intensive businesses.