Why Some Businesses Should Not Take Venture Capital Funding
Growing your business can seem overwhelming when you don’t have the proper venture capital funding. Many small and large business owners alike are tempted to take out venture capital funding as a way to grow their business quicker.
While receiving funding from a venture capitalist may give you a kickstart on finances, it’s not always the best financial decision. Let’s go over the disadvantages of venture capital funding and some better solutions for your business.
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If you have a business or startup, you’ve probably already begun exploring avenues for funding and financial help. One of the most popular funding methods is obtaining money from venture capitalists. Venture capital, often abbreviated as VC, is when investors give money to a startup that they believe has strong long-term growth potential.
It usually comes from investment banks, a financial institution, or a well-off investor. The investor usually receives equity in the company and the ability to make company decisions. This means you may not really be your own boss anymore, which is a deal-breaker for many small business owners.
Venture capital funding can also be given in other forms other than money. An investor might offer you managerial expertise or technical skills. No matter what they offer, you are almost always under their mercy when it comes to how and when you want to grow your business.
Investments are also managed in pools which means you may have more than one investor. Some obvious disadvantages of venture capital funding include:
- Forced Management
- Funding Problems
- Limited Decision-Making Abilities
- Loss of Equity
Many startups may feel like venture capital funding is their only option if they want to have a successful business. This is far from the truth.
Before taking any funding from venture capitalists, make sure to weigh the pros and cons. While you may have more access to marketing and industry experience, it’s important to know what you may be giving up to receive funding.
Some things to consider before taking venture capital funding:
- Understand the investor’s goals for their investment
- Ask them about their future exit strategies
- Make sure they don’t want to exit their holdings in an initial public offering
- Ask about liquidity events
- Make sure you see eye to eye
- Ensure you can retain control of your business
Let’s look at some of the main disadvantages of venture capital funding and why it might not be the best idea for your startup.
Venture capitalists always want you to grow as quickly as possible because they have returns and obligations. They may encourage you to make poor business decisions so they can get their money back quicker. More money at the beginning doesn’t always equal a lucrative and stable business.
Anyone that is on a time crunch will pressure you to grow quicker so they can see their money get back into their pockets faster. Therefore, more people are choosing to make money from high-net-worth individuals or family offices. These types of investors are usually not on a time crunch placed on them by a company.
Since many venture capitalists will place themselves as managers or remove managers from your company, they can force you to grow your company larger and quicker than you would like. While having someone in charge who has years of business experience, changing your management team is less than ideal.
You never want employees or other managers to feel like funding is being held over their heads. This can easily cause a bad business culture where people feel uncomfortable around your venture capitalists.
Unlike family investors or angel investors, venture capitalists have to meet key metrics before they can join additional rounds of funding for your business. This means you may have funded some years and lose if you aren’t gaining enough revenue or making enough returns.
It can make your company look poor if you lose the main investor. However, based on strict requirements, investors may simply not be able to always be there for you. They may also place harsh requirements on you and your business.
Each quarter or year, you will need to meet certain thresholds to ensure that the investors are getting enough of their return.
Startups often turn to venture capital funding because it gives them a way to begin their business and have access to more money. While people see the visions of businesses failing all the time, they fail to consider the fact that the failure might lie in the funding.
Taking venture capital funding can allow your business to grow exponentially in a short period of time, but is this always the best idea? Businesses that grow too quickly are often more likely to lose clientele after the popularity of their business dives just as fast as it appeared.
When you take venture capital funding, you also lose much of your freedom when it comes to business decisions and where you want to use your money. Venture capitalists may pressure you to grow your startup much quicker and at a larger scale than is ideal at the beginning. Before you know it, you have invested all of the venture capital funding into a version of your business that you may have never wanted in the first place.
Then, even worse, your cash starts to run low, and the investors are still searching for their returns and payments. This has been the case for many businesses you have heard of and bought from such as Warby Parker, Casper, and Outdoor Voices.
Maybe you have even bought from these companies before and had no idea they are running out of cash flow. It can stay well-hidden for a while, but eventually, the doors will close due to low returns.
Keep in mind that scaling your business will also require a vast amount of marketing and customer acquisition costs. Most of these acquisition costs come with high fees paid to Facebook, Google, and other platforms to keep your business advertised.
Many of the startups that fall prey to venture capital funding are offering a low-cost service or item. It makes sense that people want high-quality products at lower prices and this idea is a great business model but using venture capital funding can ruin it.
Many successful businesses start small and grow slowly. Be wary of venture capitalists that want to boom your startup immediately. Real growth and real revenue takes patience and years of work.
Of course, with any funding, you may lose some equity. That is the downside of borrowing money to grow your business. However, venture capital funding often involves giving away much more of your business than with other types of funding.
Make sure to not give away too much of an equity stake in your company. Even venture capitalists who share your company’s business vision can still take too much equity. This is one of the major reasons why considering private equity investment could help your startup in the long run.
Whether you are looking for funding or searching for high-return investments, there are some other options besides venture capital funding. They come with their own disadvantages, but the advantages far outweigh the cons.
Many small businesses and startups that are cash cows can benefit from more funding methods instead of receiving venture capital funding. Cash cows may be part of low-growth markets, but they still have a strong potential in terms of return.
This makes it very attractive to investors. Investors in cash cows are paid monthly or quarterly which means they will get returns much faster than if they did venture capital funding. Cash cows also give a consistent cash flow over their lifespan, even when they are acquired and paid off.
Investors in cash cows are more likely to receive more funding over the long run. They are considered low risk and high reward.
Investors will often look at your startup and the market to decide on the type of business you have. There are four main categories that your business could fall into:
- Cash cow
- Question mark
You can also determine what category your business is and what specific products within your business are. Usually, to be a cash cow you have to:
- Have return assets that are greater than the market growth rate
- Increase dividends due to ample cash flows
- Slow-growth companies or business units in other brands
- High-profit margins
- Low maintenance
- Low risk, high reward
- Little investment capital
Your business could also be a cash cow in one phase of growth, but not in another. Investors find cash cows attractive because it doesn’t require them to provide too much upfront funding and they don’t have to worry about maintenance.
If your startup is a cash cow, you will also be able to receive more funding without needing to lose as much of your freedom to venture capitalists.
Angel investors are a great alternative to funding a startup. They also focus on companies with high-growth and high-return potential. They will also take equity, but often a much smaller amount than taken by venture capitalists.
Angel investors also tend to be more patient with entrepreneurs than large companies. They will also offer smaller dollar amounts and give a longer window for returns than venture capitalists. This takes away much of the pressure to grow your business too quickly or feel pressure to give away your management team.
Angel investors may still offer to be part of the management team or want some type of control of the company, but usually much less than venture capitalists. Part of the reason for this is because angel investors will often already be beyond the first few phases of business growth.
The business is often already established, but still needs some extra capital to push their business to the next level. They may also need some extra capital to bring in a new product or service.
Angel investors also have more money on the line because they are private investors rather than putting money into a pool. For this reason, angel investors will offer mentorship to you and your employees. This can be a great way to get business advice and learn how to properly grow your company.
Overall, you can receive more flexible funding and keep your own vision for your startup. Like venture capitalists though, angel investors will also want an exit strategy. They still want their profit and may have your business acquired by another company or do a public offering.
Some of the advantages of angel investing are:
- Less risky than debt financing
- Often more flexible than venture capitalist funding
- Angel investors want a personal opportunity as well as an investment
- Your business will be more acknowledged and cared for than with venture capitalists
Here’s how to find an angel investor:
Angel investors can come in a wide variety of situations. They may be people you already know. Usually, angel investors are:
- Individuals with a high-net-worth looking for investing opportunities
- Family and friends
- Group of investors
Like with venture capitalist funding, always discuss with the angel investor what their long-term goals are and any exit strategies they may be considering.
While venture capitalist funding might be the first idea of receiving money for a small business, it’s not always the best idea. It can come with a total loss of control of your business and force you to grow your startup much quicker than you would like.
A business that grows too quickly may seem like a good plan, but the business often becomes unstable and loses returns over time. Always review all of your funding options before deciding on how to move forward.
About the Author
Jonathan Hung is one of the most active angel investors in Southern California, his mission is to drive value creation within each portfolio company. In support of this mission, he serves as Co-Managing Partner at – Unicorn Venture Partners.
Jonathan and his team target investments in US companies that have global market potential with a focus on long-term growth expansion to East Asian markets.
Jonathan developed his investing prowess as a Managing Member for his family office fund, J Heart Ventures, which made investments in start-up companies such as Gyft, ChowNow, Miso Robotics, Clover Health, Bitmain, to name a few startups he funded.
Jonathan has various degrees from the University of Southern California, London School of Economics, Massachusetts Institute of Technology, and The Wharton School at the University of Pennsylvania.