You start a company. You pitch it to a partner at a big-name venture capital firm. The partner decides your company has huge potential, gives it a unicorn valuation, and gives you tens of millions of funding, or maybe even more.
Time to celebrate, right? Maybe not, according to Eric Paley, managing partner at the VC firm Founder Collective and co-founder of 3D dental impression company Brontes, acquired by 3M in 2006. Paley frequently takes aim at the venture capital industry, and in a recent piece on TechCrunch, he explains in detail why VC funding can be so bad for a startup that it's actually toxic.
A lot of what he says makes really good sense. Here's some of what he says is bad about getting venture capital money.
1. VCs push startups to grow fast at all costs.
A healthy proportion of startups fail. The VC industry is built on the idea that it doesn't really matter if most of the companies you fund go belly-up because you're hoping that one of them will turn out to be the next Uber, and more than make up for your losses on the rest.
While that model makes sense for VCs, it means that small or even moderate successes are of little interest to them. So while it might be great for your startup to have slow, steady growth, that will be of zero interest to most VCs. Instead, they'll pressure you to accelerate growth and scale quickly. That might look like the smart thing to do because if your company gains size and visibility quickly, it will make it harder for competitors to overtake you.
But scaling fast isn't the best choice for every startup. Trying to grow too fast has killed many a startup that could have lived a long and healthy life if only the founders had taken things more slowly. If you attempt to grow too fast and fail, your VC will chalk it up as a losing bet and keep on pressuring other founders to "go big or go home." You, on the other hand, will be left with no company of your own.
2. Small problems don't get fixed so they turn into big ones.
Under pressure to grow rapidly founders are tempted to ignore their companies' problems, believing that they can "fix it as we scale." But, Paley points out, scaling quickly is in itself extremely difficult so that most founders wrapped up in the effort to go big and avoid going home don't have the bandwidth to solve pernicious business problems such as supply-chain issues or inadequate quality control. It's almost impossible to fix an ongoing problem while growing rapidly, he says.
3. Insisting on growth can mean sacrificing future profitability.
No one expects any startup to be profitable in its early life. But VC funding can make it difficult to ever turn a profit. That's because of what Paley calls the "marginal dollar problem." In any normal business situation, you would constantly be looking to increase revenues--so long as what you have to spend to do it makes sense. Hiring an overpaid salesperson who brings in new business but not nearly enough to justify his or her paycheck is one good example of how the pursuit of growth at all costs can destroy a company's long-term viability. That might be a worthwhile tradeoff for a VC, but it probably isn't worthwhile for a founder.
4. They push founders to sacrifice a viable present for an improbable future.
"Starting and selling a company for $100 million is an outlier event in terms of pure entrepreneurial probability, but such outcomes are viewed as well short of success in many corners of today's startup world," Paley writes in a different TechCrunch piece. So when the opportunity for a $100 million sale comes along many VCs will encourage founders to turn it down, hoping that as the startup keeps scaling, it can become a unicorn. "My advice: Don't give up your present for a future you haven't validated," Paley writes.
5. A win for them isn't necessarily one for you.
Accepting venture capital funding inevitably means giving up some control of your startup, but at least you'll make more money than you would without it--right? Well no, not necessarily. In fact, he says, it's quite possible that you could sell your startup for $1 billion but wind up with less money in your pocket than someone who sold for $100 million. That's because it will take several rounds of funding to get to that billion-dollar valuation, and at every round you'll have to give up more of your stake in the company. You'll wind up with a smaller piece of a bigger pie, when sometimes the big piece of a smaller pie is worth more.
To illustrate, Paley compares the sale of the Huffington Post, reportedly for $314 million with that of TechCrunch for $30 million. Because of the dilution effect mentioned above, Arianna Huffington received about $18 million from the Huffington Post sale, while TechCrunch founder Michael Arrington wound up with $24 million. "To a VC, TechCrunch's sale would have been a 'loss,' and many VCs would have pushed Michael not to sell. Yet Arrington was more successful, financially, than Huffington," he writes.
And that's the whole problem--what's best for VCs often isn't best for founders. When these conflicts arise, do you believe they'll put your interests ahead of their investors' and their own? If not, maybe you shouldn't put your startup's fate in their hands.