December 23, 2019

The 3 Downsides to Venture Capital

Venture capital can be used to grow your business quickly, but it comes at a cost and it isn't for every Founder.

The 3 Downsides to Venture Capital

A venture capital firm’s support can go a long way. Beyond the windfall of capital in your bank account to be used to grow your business quickly, a venture capital firm’s backing can introduce your startup to invaluable business resources and successful, savvy networks. What are the 3 Downsides to Venture Capital?

But, like most things, venture capital comes at a cost and it isn’t for every Founder. For example, it can busy startups with preparing for the next round or valuation instead of developing a solid product or proven business model, and it can push a company in a direction that it may not be well-suited to go.

Here are the top downsides to venture capital that all startups should consider before pursuing it.

Loss of control.

Venture capital might feel like a gift to cash-strapped startups. However, it comes with strings attached. After venture capitalists give you the big money, investors own a stake in your company. And so, accepting venture capital means some loss of control and a loss of equity in what you’re building.

This is especially true for early investors to a startup, when companies might feel most desperate for their first dose of funding. According to David Van Horne, a partner in the technology practice at law firm Goodwin Procter, the money that you raise early on will be the “most expensive money you ever take.” This is because the equity that early investors receive is given at a time when your company has the least value, and so will become proportionally larger with a company’s success.

This fear of dilution is why some startups that have venture capital backing already turn to venture debt, which can be used as a means to stretch the time before the next round of funding is needed.

Too much growth, too quickly.

Landing a big check to build your startup’s infrastructure (by hiring staff or make a big technology purchase) is an exciting way to help your company grow. But, it’s also risky.

For one thing, money from investors can bring immense pressure to be profitable too soon, which can lead to business decisions that aren’t in line with a company’s core values. This pressure to grow also often pushes startups to prematurely focus on customer acquisition rather than customer retention, the latter of which is a key to long-term success.

Even more, if your company hasn’t figured out how to generate a profit with its products and services, taking big money early on and expanding too quickly could prove fatal. In fact, premature scaling is one of the top reasons that startups fail. For example, startups should ensure that there is sufficient work demand before hiring a new staff member with raised funds rather than making a new hire that’s tasked with building a new, non-existent area of business.

A drain of time and energy.

The fundraising experience can be arduous and exhausting. It takes time and energy, and lots of it. A few weeks of meetings and pitches can quickly turn into months of meetings and pitches, which is time not spent developing your product. Also, the distraction of fundraising for a startup’s leadership can leave a team lacking direction.

Even more, when you take your first pile of investor cash and inject it into your business, you might inadvertently be signing up for rounds and rounds that follow. When startups use the cash to grow infrastructure, but are unable to grow their profit margins, they often become dependent on their next round of funding. Consider the example above of hiring a new staff member tasked with building a new area of business.

Like with most things, money is a part of the formula for success. But, it’s not the end-all-be-all to launching a successful business, especially if the money isn’t generated by profit. Fortunately, there are new options for funding a startup that go beyond venture capital without the downsides. (Want to learn more? Let’s talk.)