Money is a necessity for starting and growing a company. That is why it is so surprising that only .05% of startups raise venture capital (VC) according to Fundera.
Why are so many companies shying away from, or even rejecting, the VC model? As a young tech founder, I had the notion that raising VC funds was the ultimate validation of my vision as well as the fastest way to grow and share that vision.
However, through my process and Series A round of fundraising, I had an epiphany. The VC business model did not align with my vision for the company. In fact, it was exactly the opposite. Large venture capital investment firms are focused on generating a large return on investment (ROI). Over the course of several meetings, I realized that VC investors were not focused on my vision of growth. They were focused on how to grow the company as fast as possible to sell it for the largest profit. Here are the top three reasons I determined VC wasn’t right for me.
1. Prestige doesn’t guarantee success
While it may seem like a VC investment is the ticket to fast growth, many of those investments are not profitable. In fact, The Wall Street Journal once claimed that 3 out of 4 VC-backed startups fail. For VCs, the name of the game is low-probability, high reward: They know that most of their startups will fail, and they are ok about accepting this risk and walking away because it’s not their business. They didn’t put in 20-hour workdays for years to get the company off the ground or invest their life savings into their dream. Instead, they are investors who think in terms of cost and benefit.
2. Someone else pulls the strings
The more I became immersed in the VC process, the more I saw how much control I would be losing. Taking funds means that you are giving some of your power away, and you may need to consult other people and stakeholders when running the company. VC investors want to keep a close eye on their investments, and they often want a say in decisions that impact the bottom line long or short term.
To ensure this, VC firms often serve on the board or become direct employees of the company. So, if you do decide to seek funding, you must be prepared to compromise. You’ll need to align your vision of the company to the desires of the board. If you are not prepared to do this, then VC may not be the best route for your funding needs.
3. VC investors make money if a company succeeds or fails
The other puzzling aspect of raising capital is the way the VC investors make money. They are very well compensated on the front end of the deal. Yes, they are motivated by a back-end share of the profits as well, but should a company not succeed, the VC is still making money from their upfront fees. According to an opinion piece in TechCrunch, 95 percent of funded companies are not bringing in the profits to justify the fees, risk, or liquidation of the companies. VC firms generally get paid a management fee up front as well as carried interest received from a percentage of the profits during a sale. This means that a VC investor can make money regardless of a sale of the company, and that the VC investors’ target is to make even more on the backend with a speedy sale.
VC investments offer a path for astronomical growth in an expedited manner. However, as with all things, this comes with a cost. Involving VC firms in your business means the pressure is on and the stakes are high. You have a short window of time to prove your business is capable of the ROI a VC firm desires. You will also need to maintain this growth while negotiating new business channels, as most VC firms will require input on business decisions in exchange for their investment funds.
However, for founders like me who want to build our companies on our terms and potentially provide employment for future generations, the “grow fast and sell” model may not be ideal. Be sure you understand the ins and outs of the different types of funding and all the ways the funding will affect your company, both in the short and long term. Then you can choose the course that best aligns with your vision.