If it comes to a point where the only thing stopping you from taking the market by storm is the capital, what do you do? Seek a venture capitalist firm – that is what many startups consider. But before doing that, you should also know the cons of VC funding. With a complete understanding, you can then focus on growing your startup.
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Cons of Venture Capital Funding
Sure, getting backed by a venture capital firm is a huge thing. Not only do they provide the seed money, but they also help you in so many other ways. But here are the possible disadvantages that you should know about and embrace. If you can do that, you can have a smoother working relationship and path to success.
1. Finding Investors Is Time-consuming and Distracting
The challenge of seeking an investor is not only securing capital. Many startup founders also do not have the time. Seeking venture capital, in most cases, can take three months on average.
Fundraising becomes even more challenging when time-pressed. Hence, it would be best to prepare the necessary months and start the process months ahead before you need the capital. In this way, you can manage time, allowing you to manage your business while seeking investors.
2. Getting Venture Capital Fund Is Extremely Difficult
As many founders found out, a game-changing business idea is not enough to convince VCs to write a check. In some estimates, only one startup gets funded per hundred proposals. Others estimate the number to be four in every thousand.
To illustrate the difficulty of getting venture capital, consider this figure provided by the National Venture Capital Association (NVCA). In 2020, the number of deals completed was only 4,859, including angel investments.
For very early-stage startups, it may be too soon to raise funds. Suppose you already have a Minimum Viable Product (MVP). In this case, you might consider a Seed Accelerator Program that can quickly scale your business. Without an MVP, An Incubator Program may be more suitable as you access mentors and resources to help develop your business.
3. Due Diligence Is Needed But Takes a Long Time
Venture capital firms, when making investments, are essentially investing money from outside sources. For this reason, they need to exercise extensive due diligence.
One of the things they would do is scrutinize your business fundamentals and value proposition. In particular, they want to make sure that there is a market. If so, they will want to know if you can scale the business.
No matter how positive the outlook is, VCs will not commit until after a thorough review of the founding management team. Aside from looking at your background, they will also check your company’s legal and financial position.
Due diligence, however, can take several months. Should they find any issues, you should be glad they did. After all, it is easier to fix problems early on than later. Because of that, your company is more likely to achieve success. And as you continue to grow, it is easier to attract more investors in a future round of funding.
4. Reduced Founder Ownership Stake
VCs do not provide funds without a catch. The venture capital firm will take a portion of the ownership equity stake in exchange for capital.
Once your business outgrows the initial funding, you need to raise an additional round and possibly more. With every round, you are essentially diluting your equity.
Reduced ownership stake is not the only concern. You will also have reduced decision-making power and control of your company. And if you were to underperform, the VC may take over the business.
5. Venture Capital Is More Expensive
Over the long term, venture capital financing costs more than bank loans. Consider a startup with a valuation of $10 million needing to raise $1 million.
If the company takes out an SBA loan for ten years at an 11.5% rate, the interest paid would be nearly $687 thousand. Meanwhile, a $1 million investment would give the VC a 10% equity.
Ten years from now, if the company sells for $100 million, the founder would have only paid $687 thousand. On the other hand, the VC would take $10 million upon a successful exit.
6. No Negotiation Leverage
Only a few founders have leverage in negotiations. One reason is that most fundraisers do not have much choice but seek venture capital. In this case, the VCs attitude is “take it or leave it.”
But there are circumstances in which a startup may have leverage. For example, there is more than one interested VC firm. Being pursued and “oversubscribed” gives the founder more negotiation power.
As if receiving an offer from a VC is not hard enough, you might have to reject most of them. This difficulty in getting a reasonable deal is also why you should seek funds early.
One way to simplify the venture funding process is to avail of the services of Allianse. They have experts who can dispense invaluable guidance on seeking VC investors. Moreover, they provide an advanced AI startup investor platform that matches investors and startups.
7. Need Board of Directors and a Formal Reporting Structure
As part of a deal, the venture capital partners will require you to set up a board of directors. Furthermore, you will also need to establish an internal structure. These two conditions can be beneficial. For example, they help facilitate growth and promote transparency.
But there are also disadvantages. The amount of control you have over the company, for instance, would be less. As a result, you have less flexibility over decision-making and operation.
Nonetheless, it would be best to understand why VC investors take this measure. It is their way of protecting their interests. And being on the board lets them provide governance oversight. At any given time, problems may occur, especially as the business grows. Before they get out of hand, the investors can help find the most appropriate solutions.
You would also need to keep a meticulous record of measurable metrics. That is because you will have to report to the board of directors. Having such an internal structure and transparency goes a long way to appease investors.
8. VCs Expect You to Grow at a Rapid Rate
A lot of pressure comes with receiving venture capital funds. VCs will want their company portfolio to grow at tremendous rates for obvious reasons. And as the value of your business increases, they cannot wait for the day it is ready for exit. Usually, it can be through M&A or IPO. Regardless of which, that is how they can get a return on their investment plus the profit.
Now, venture capitalists differ in attitude and personality. Some, for instance, are more patient, while others can be too pushy. You can, thus, expect to feel pressure, which in turn raises your stress level.
It would be in your best interest to work with more reasonable investors. Usually, they are the ones who share similar values, visions, and goals as you. But the most important key to mitigating pressure and stress is regular communication.
On managing the company, some entrepreneurs tend to micromanage many or all the company’s departments. The heavy workload, in this case, will exacerbate the pressure brought about by the need to appreciate the value of the company. You can avoid burning yourself out by delegating. This way, you can focus on the most critical aspects of your business.
9. Funds Released Based on Performance Schedule
Startups do not receive the full seed money after signing a deal with a venture capital firm. Usually, the VC will provide a certain amount after startups hit specific milestones.
The performance schedules may comprise, among others, revenue and customer acquisition. VCs will also present other metrics, which may or may not be subject to negotiation.
Although chasing milestones can be stressful and distract you from some crucial business aspects, it can also be a good thing. Each accomplished goal is a step towards appreciating the value of your company. Investors are aware of this, so they include performance schedules as part of the deal.
10. Possibility of Losing Business
Ineptitude, negligence, and risky behaviors can lead to a business floundering. It is even worse when some founders are reckless in spending, especially for personal use. These are matters that, understandably, do not sit well with the board of directors and investors.
As a consequence, the investors may bring in a new management team. The board can vote to let go of the underperforming founder. And so, the best way to avoid this issue is to be serious in running the company. In most cases, the board’s advice is for the better of the business. You should consider and accept their collective wisdom. Furthermore, keep communicating regularly to discuss plans, goals, and accomplishments.
The Advantage of Knowing Venture Capital Disadvantages
One popular piece of advice often dispensed is understanding why a business failed. It is not only so you can avoid making the same mistakes. The most compelling reason is so that you would know the solution. If such problems do occur, you already know what to do.
Likewise, knowing the possible difficulties and challenges you may face when seeking venture capital is good. For one, you know what you are getting into, so there would be no unpleasant surprises. More importantly, you can embrace the tradeoffs and focus on growing your business.