Notable Drawbacks of Venture Capital Financing for Fledging Business
What are the cons of using venture capital to raise capital for a startup? Originally appeared on Quora: the place to gain and share knowledge, empowering people to learn from others and better understand the world.
Many entrepreneurs don’t understand the cruel reality of fundraising. Just because you want to raise venture capital doesn’t mean you will raise venture capital.
Consider this ratio: 100:1. That’s one investment for every one hundred face to face meetings a typical VC will take. Raising money is unbelievably hard.
And fundraising is all-encompassing. It’s essentially a second job. No, make that a second first job.
Fundraising is fickle too. Imagine you’re climbing a mountain, and you’re just about to get to the peak. You pull yourself up to the peak and someone kicks you off the peak and you fall all the way to the bottom. Now you have to start all over again. That’s fundraising.
So, don’t raise venture funding if you are faint of heart. That’s the first reason not to raise venture funding.
But there are many more reasons not to raise venture funding including…
A. You Don’t Need to Raise Venture Funding
I was talking the other day with a CEO about how to keep growing his company. His company was at $5 million ARR, insanely profitable, and growing at 100% per year on year. Yet he was considering raising venture funding.
I asked him why. He said he thought venture funding would help him grow faster. Maybe, but likely not.
We dug deeper, and he determined that hiring great people, not funding, was the constraint on his growth. Venture funding wouldn’t help him. In fact venture funding would likely hurt him (see all the reasons listed below). Or…
B. Your Startup Isn’t in A Segment Vcs Are Interested In
Don’t feel bad if you fall into this category because most startups aren’t in a segment VCs are interested in. It doesn’t mean you can’t make a ton of money. And it doesn’t mean your business isn’t a great business. Maybe…
C. Your Business Isn’t Growing Fast Enough
There’s a natural growth rate every business has. And your business might fall into that category.
For example, let’s say your revenue is growing from $0.5 million to $1 million to $1.7 million to $2.5 million to $3.5 million over the next five years. And you expect to grow revenue by $0.7 million per year.
This is a great business! But it’s not likely venture fundable. To be successful raising money, you’re going to have to adjust your plan in a way that’s not natural for your business.
Don’t do it! You’ll likely fail at raising money. Or you’ll fail and lose everything if you are successful raising money. Or maybe…
D. You Don’t Want to Give Up Control
Make no mistake, the second you take venture funding, regardless of your percentage ownership in the company, you’ve effectively ceded control of your company to your investors. And you will not gain control back until your company is cash flow positive.
Look at what happened to former Uber CEO Travis Kalanick if you don’t believe me. Kalanick had voting control of the company, yet his investors forced him out of the company.
How did the investors do this? Uber was losing a boatload of money because of its grow at all costs strategy. Yes, Uber grew to a huge valuation and size, but Uber needed more money to keep growing.
The investors made it clear to Kalanick that the price of that funding included his resignation. Kalanick resigned.
You need to be intellectually honest with yourself. You are giving up control of your company when you take on outside funding. You need to be okay with this. Finally,…
E. An Acceptable Exit Just Got Much Bigger
A self-funded company that sells (exits) at $30M where the founders own 80% of the company is a great outcome. However, that same exit as a venture backed company is not a great outcome for you or your investors.
Depending upon how much money you raised, you and your investors might not make any money at all. You might have to exit at a $300 million valuation to get the same financial return.
Contributed by Brett Fox, Fmr CEO @ Touchstone Semiconductor