If you are the owner of a startup business who has just entered the venture capital world, you might be under the impression that venture capital funding can only help your business on its way to success. Unfortunately, it is not that simple, as VC funding can hurt startup businesses just as much as it can boost their development. We have compiled several points that you should consider before exposing your business to the risks of venture capital, in order to avoid potentially having your startup hurt by VC investors. In other words, here are the top reasons to avoid VC funding for your startup.
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1. “Go big or go home” mentality.
Virtually every startup harmed by Venture Capital Investors was lured in by the promise of a single, life-changing deal that then either happened too late or not at all. This scenario is among the most common reasons why many startups fail before even entering the market. Venture Capital funds are generally pursuing deals in excess of $100 million. As such, closing only a handful of successful deals per year – which help to compensate for any unsuccessful investments – is considered a major success. On the contrary, the likelihood of your business being among those few ultra-successful deals is fairly low. Hence, our advice is to carefully consider the risks VCs pose to startups and whether you are willing to take on such risk, which could ultimately cost you your business.
2. Grow, grow, grow.
Further, VC funding can hurt startup business by exerting constant growth pressure. Naturally, most startups cannot keep up with such demanding growth expectations. VCs typically want (and need) a startup to increase its valuation by 10x to 30x within only a few years – an unsustainable rate of growth. Forcing your business to grow artificially before it is actually ready to do so might make it the next startup harmed by Venture Capital Investors”. Consequently, startups frequently grow their business (investments, marketing, work force) with VC money, while actual revenues from the core business are barely increasing to justify this growth. Sooner or later, this kind of VC funding can hurt startups in a significant way.
3. A founder but not the owner.
One of the most significant reasons to avoid VC funding for your startup will always be the decrease of your ownership stake in your business. Understandably, it is not possible to receive funding without sacrificing a portion of your startup to your investors. However, after the seed round, which is mostly funded by friends and family, turning towards VC funding can lower your stake in your business by 50% or more. Such a significant decrease in your ownership stake is among the major risks VCs pose to startups which may be justified by the potential upside of earning millions later on. However, that is not always the case. The loss of over 50% of your company can cost you the ability to actively manage your business, which may outweigh the potential benefits in many cases.
4. You cannot always trust VC’s judgment.
As mentioned above, the success rate of VC-funded startups is not worth the praise that VCs often receive. VCs are often perceived as credible institutions that raise large sums of money and operate pursuant to a fool-proof formula. In reality, however, many VCs evaluate investment opportunities via simple ratios and a mix of faith and intuition. To that end, an analysis revealed that more than 50% of VCs deliver low single-digit returns – worse than the S&P 500 – and 1 out every 5 funds achieves negative returns, i.e., returns below 0%.
5. Raising money is not the recipe for success.
The common misconception that raising more money will automatically lead to more success is among the frequent reasons to avoid VC funding for your startup. VC funding operates on raising large amounts of money, while forcing artificial growth that has the potential to irrevocably harm a business. Collected data reveals that 75% of major tech companies raised less than $100 million via VC funding. If it were left to VC investors to decide these companies’ futures, they would likely not have accumulated billions in revenues and profits in the following years.
In conclusion, VC funding can hurt startup companies, but it can also lead them to immeasurable success – the key is in locating the right balance between your startup’s needs and your VC’s wishes. You should always seek to define clear goals for your startup and what a successful future would look like for your business. Some founders may simply wish to make a positive impact with their startup, which might not be in line with the goals of most VCs. Oftentimes, differences between the founder’s viewpoint and the VCs’ opinions are visible in the amount of money raised, the hours worked, and the control over the company, while owner’s rights are often limited. Of course, if all of this advice seems too complicated to grasp, contacting one of our experienced startup attorneys could be the first step in ensuring the success of your business.
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