Shows like The Shark Tank and movies like The Social Network have made the notion of seeking out venture capital hotter than ever. But it’s not always necessary. And it’s not always good for your business.
In fact, there are compelling reasons why seeking VC funding could be the worst possible move that you could make for the business. All that money may look attractive, but signing a VC deal could be the equivalent of signing your own death warrant.
You won’t learn how to run your own business.
Venture capital looks attractive to many founders simply because founders feel as though getting the VC money will help them avoid the hard work and challenges that go along with starting a business. It’s natural to want to mitigate your own risk, and it’s natural to want to “go big,” fast.
But you’re losing out on something important.
There’s a lot to be said for learning what it takes to build a solid business from the ground up, and for feeling the pleasure that comes along with having to make it work. Even the sleepless nights and the worries about how you’ll make the next payroll have value. They turn you into a better entrepreneur and business person. They teach you how to think outside the box. They force you to ask yourself how bad you want this. And they push you to create real value.
Some entrepreneurs imagine that the VC firm will provide them with a savvy partner who can make up for their lack of knowledge and experience, a fine mentor who will turn them into the moguls they want to be. But this, too, is an illusion and something many VCs sell entrepreneurs on to get a better deal.
First, you’re not going to get nearly enough of the VC’s attention to learn much of anything. Even in the late 90s Venture Capital firms were reducing the amount of time they spent consulting with founders. A Harvard Business Review article called How Venture Capital Works indicated that VCs were spending less than 2 hours each week advising or mentoring companies in their portfolios. This means you’re not really getting the benefit of any additional expertise when you sign on that dotted line.
As it is, the advice that you do get may not be anything to write home about. The same report notes that most VCs have never worked in the industries they fund, which means that they don’t actually know anything at all about your business or what you’re trying to accomplish with it. They know just enough to be dangerous—to demand business decisions which might be detrimental or to block business decisions which might be advantageous.
You’ll be saddled with another boss.
The VCs may not expect to spend much time paying attention to you, but they do expect you to spend a great deal of time paying attention to them.
The Seed and Startup Capital Blog actively argues against using venture capital. One of the major points that the blog makes is that your role, as the founder, will ultimately shift from the moment that you reach out to accept VC money.
“As soon as venture capitalists become involved, the founder’s role shifts from critical company building functions to preparing reports, attending endless meetings, writing memos, and hand-holding impatient and/or meddlesome investors.”
There are strings attached to that money. This is America, no one gives away money without expecting something in return, and if you believe otherwise you are just completely naïve. It’s not being given to you as a gift. It’s not a loan. It’s an investment that comes with the understanding that you’ll give up 40% of your company, or more. The VC gets the right to tell you how to run your business, and ultimately may have more control over your business than you do. And in fact, it’s like having a traditional boss in more ways in one. Once you take the deal there’s no guarantee that you will be sticking around, for all that this was your idea, your passion, and your dream. In fact, the VC firm gets the right and the power to show you the door. They often do. You haven’t just hired a new boss. You’ve hired a new boss that has invested in your company with expectations and demands. Many VCs will be all smiles and big promises knowing with a little investment they can make big demands and take control of a an unstable company eventually outing the founders if needed.
If a venture capital firm does oust you it may not even be about making sure they get someone who can run the company better than you can. A Stanford Law School paper called VCs and the Expropriation of Entrepreneurs points out that the very structure of most VC agreements makes “firing the founder” a tempting and lucrative prospect.
Why is expropriation of founders and other early-stage investors possible? Much of it arises from powerful contractual rights routinely granted to VCs, such as control over the company’s board, strong anti-dilution and redemption rights, liquidation preferences, and control over the sources of future financings. Such contractual rights are often necessary to curb well-known incentive problems of early-stage investing, but they create significant expropriation risks. The VC, for example, may be contractually allowed to fire the founder for the sole purpose of repurchasing the founder’s stock at a symbolic price, to dilute founder’s ownership stake, or to sell the company on terms disadvantageous to founders. When the VC chooses to exercise his contractual option to expropriate, founders often have no legal recourse, and when they do, the value of such recourse is significantly reduced by the complexity and expense of litigation.
As it stands, VCs are rather clear that they believe that firing the founder is the best way to get a return on their investment. Read the blog of Venture Capitalist Fred Wilson if you’d like to hear it straight from the horse’s mouth.
The extra money isn’t really a boon.
Believe it or not, all of that extra money isn’t necessarily going to help you grow your business or make it better. If you don’t have a specific need for every dollar of the VC money you may well find yourself using it on things that make your company worse, not better: on employees you don’t need, for example, or equipment you don’t want.
Why not just save the money until you actually need it? The VCs simply won’t let you. They’ll pressure you to spend that money on the things that they think will benefit their investment. Since we have already established that most VCs are woefully out of touch with the industries they’re trying to invest in you can bet that few of these purchases will make particular sense.
How is it that venture capitalists throw money at businesses and essentially pressure them into wasting it? Because a few companies win no matter what, and they only need one or two of the companies in their portfolio to succeed. “Throwing money at it” is a hallmark of the old days where most businesses were based in manufacturing—buying more factories and scaling up more widgets was a fast track to success. Today’s companies are based on ideas.
That’s not to say there aren’t companies who can’t benefit from such an infusion. In Paul Graham’s A Unified Theory of VC Suckage Google was upheld as one such exception. Why? Because Google actually had a place for all that money: they had to use it on servers and bandwidth that helped them dominate the web. “Less fortunate startups just end up hiring armies of people to just sit around having meetings.”
Evaluate your own needs very, very well before you assume that you will be the Google in your chosen VC’s portfolio instead of one of the countless losers.
Even courting a VC offers significant risks.
You have to put significant time and energy into courting a VC. And each meeting that you have exposes you to one of two risks.
First, many VCs go to meetings with entrepreneurs with no other purpose than to steal the ideas the entrepreneurs are sharing. Those ideas are passed on to other businesses in the VC’s portfolios, or on to the similar company that the VC ultimately chooses to back.
This is obviously a big concern. Again, most of today’s businesses are built on someone’s unique intellectual property, not on the creation of widgets. Your entire business can be sunk if your idea is simply given to someone else.
In fact, VCs have a vested interest in distracting you from your primary purpose as a business: that of making money. As The Seed and Startup Capital Blog points out, it strengthens their bargaining position.
Once negotiations begin, venture capitalists will typically stall in order to push cash short companies to the brink of bankruptcy as a way of extracting additional equity and concessions at the last moment.
Given the concerns I have already raised it’s worth asking yourself why you would want to expose yourself to this risk in the first place. The rewards are often little more than poisoned fruit.
You probably don’t need a VC.
I’ve been a founder in 3 successful start-ups two of which that quickly grew past 7 figures. I have never gotten VC funding.
But I’m not some sort of prodigy. There are plenty of big name companies that didn’t use VC funding. Plenty of Fish didn’t, and it’s worth $1 billion. Gawker didn’t, and it’s now worth $150 million. TechCrunch, at $32 million, didn’t take any venture capital either. (Source: Business Insider).
If you have a truly great idea and the passion to make that idea work, then there’s a good chance you don’t need venture capitalists either. You just need the willingness to make sacrifices, and the guts to sit through a few late-night brainstorming sessions, hoping against hope that you’ll be able to hustle enough tomorrow to make your payroll at the end of the month.
I’m not claiming there is no use for a VC, there are a number of different reasons to use a VC, but if you don’t have an established business with 2 years financials and are considering a VC I would think twice. You’re giving away more then you need to, you have no real negotiating power and it’s much too early to really know what you need VC money for.
If building a successful company was easy everyone would be doing it, building a successful company takes brains, it takes guts and it takes hard work and determination. If you want to build a successful company you’re going to have to do things you don’t like, you’re going to have to work harder then you ever have, you’re going to have to make sacrifices in your life, you’re going to have to get into uncomfortable and ruthless situations, this is the business world. No VC money is going to change this, business is hard. I believe most people fail because of their inner fears; fear is what ultimately leads to failure. When you eliminate your fears you can take calculated risks and make quick and effective decisions that will lead to your success, I wouldn’t think twice about spending my entire bank account on something I believe in because I’m not afraid of failure and understand that failure is not an option, I will make it work no matter what.