BUYING A SMALL BUSINESS

2 Reasons to Avoid Venture Capital

Many growth company CEOs believe they need to raise venture capital to achieve success. Here are two reasons to reconsider.
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Our company is not a venture capital firm, so we are surprised with how many inquires we receive from CEOs, entrepreneurs, and even larger companies about the need to raise capital from an outside investor. We can only imagine how many inquiries the big VC firms receive.

Obviously, capital is often necessary to fuel a company's growth, especially when one is trying to massively scale a successful business concept. But given the downsides of raising capital from an established VC fund, we think it should be viewed more as a capital source of last resort, rather than an aspirational event in the company's growth journey.

David Steinberg, a Partner at PureTech Ventures in Boston, has experience building companies with and without venture capital. "Lots of people convince themselves they need venture capital no matter what," he told us. "For many companies that's a big mistake. Raising a round of funding from a VC might add credibility to a business, but it's customers that make or break a company. Customers don't care who your investors are."

Here are two big downsides to raising venture capital, which underscore why you should avoid it unless you absolutely cannot source funds from other sources:

1. Dilution

A blue-chip VC is going to get top dollar for their investment. In a venture capital deal this means that the larger VCs are going to be able to set their own terms and take a larger share of your equity position, potentially driving you below 50% ownership. The larger VCs will likely have close to full control over subsequent rounds of funding and the terms of those rounds, which will further dilute the founder and original owners.

2. Control

Steinberg advised us that, when you enter into a deal with a VC firm, you are in some ways gambling with a double-sided coin. The VCs can bring valuable capital and resources, but things can get ugly if the business doesn't hit its milestones. Investors will move to replace management if they think it will improve their chances of success. If that is a threat from the beginning, they will have significant ability to control decisions from the beginning. As Steinberg says, "If you open Pandora's box, you'd better be prepared for a ton of outside pressure, and you certainly won't be your own boss."

There is a time and place for venture capital. It provides much-needed funding to growing companies and can be the right choice in many cases. But given the downsides, it's dangerous to view venture capital as an aspirational goal.

Share your experiences on considering growth capital from VCs. We can be reached at karlandbill@avondalestrategicpartners.com.

Last updated: Sep 7, 2012

KARL STARK AND BILL STEWART | Columnist | Co-founders, Avondale

Karl Stark and Bill Stewart are managing directors and co-founders of Avondale, a strategic advisory firm focused on growing companies. Avondale, based in Chicago, is a high-growth company itself and is a two-time Inc. 500 honoree.

The opinions expressed here by Inc.com columnists are their own, not those of Inc.com.



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