3 Questions For Startups To Consider Before Accepting VC Money
March 19, 2020 2:00 AM
Since its birth more than 70 years ago, venture capital has grown exponentially. Georges Doriot sparked a sea change for small businesses when he started the world’s first publicly owned VC firm in 1946. In 2019 alone, more than $136 billion has been invested by VCs.
For new startups, VC investment has long been an attractive option for securing funding. However, not all startups are the same. In fact, the very reason for their success usually lies in their unique qualities. Accordingly, VC funding might not always be the best funding option for every startup.
As the managing partner of a firm that provides funding without requiring entrepreneurs to give up equity, I’ve seen the benefits and challenges of VCs firsthand. Here are three critical questions business owners should ask themselves before deciding whether to pursue the VC route or opt for alternative funding sources.
1. Does VC funding make sense given my business’s current growth stage?
There are typically four stages in any startup’s lifecycle, each of which involves different types of funding rounds: seed-stage, corresponding to the seed funding round; early-stage, involving A-B rounds; late-stage, in which startups secure their C-E rounds; and finally, the transition from a private to publicly traded company, which requires public backing via an initial public offering (IPO).
VCs are perfect for seed- and early-stage startups because they enable young companies to raise much-needed capital for an idea or prototype before they are able to produce revenue. However, the trade-off of equity for cash can exact too high a cost for late-stage startups that are either profitable or on the path to strong profitability. The later the stage, the bigger the loss of equity. Ensure you explore your options if you want to retain ownership of your assets.
2. How do my business goals align with those of my investors?
For the sake of a startup’s future growth, it is essential that investors share the company’s goals. Failure to align from the outset could lead to problems further down the line.
VCs operate with a structured business model: select, invest, grow and exit when their investee is publicly listed. If the startup doesn’t plan to eventually go public or get acquired, VC investment can alter the strategic direction of the business. For example, your investor might put your company on the path to public listing, while staying private would be a more sustainable decision. Indeed, an increasing number of startups in the U.S. are avoiding IPOs, and there has been a drop in the number of publicly listed companies as new businesses seek alternatives to the arduous planning and disclosure processes associated with IPOs.
It is important for startups to weigh up all their options and consider what funding options will best support their long-term plans. If the goal is to grow at a breakneck pace in order to beef up valuation, then VCs provide an excellent funding route. However, for companies whose vision doesn’t necessarily involve going public, founders might consider alternative options, such as angel investors, crowdfunding, revenue-based financing and small-business loans.
3. Is a major capital injection worth giving up control?
When founders seek external investment for their young businesses, they typically face a trade-off between control and growth. Often, the founders are only minority owners by the completion of the Series B funding round. Their freedom is therefore far more limited.
VCs will typically want to appoint new board members, and it’s possible that those board members will want to shift strategic business decisions away from founders’ preferences. VCs are under the thumb of limited partners who provide the capital for their investments. These LPs rely on the company benefitting from VC investment to either be sold or go public in order to recoup their money. They, therefore, can influence purchases of the company to ensure they get the most from their investment. For example, if the startup is offered what the VC deems a small amount for an exit, the VCs will block the sale in favor of a better deal. This is important to consider, as your startup might need to remain independent until you can find a buyer suitable to the VC.
For early-stage startups, the loss of control is often well-worth the financial boost to kick start their business. However, for those on the path to high profitability, the loss of control can be damaging for long-term business prosperity.
Choosing a funding route is one of the most important strategic decisions a startup executive will need to make. As a company produces revenue and sustains growth, they must consider the long-term costs and benefits of their chosen route for their business. This is equally as important as the consideration of the short-term gains that different funding methods bring.
Publicly listed companies would be considered negligent if the executives did not investigate all their funding options. Privately held companies are different in this sense, but nevertheless, their executives have a responsibility to ensure that they make the smartest strategic choices for the business. Asking themselves these questions might involve challenging conversations — but it’s key to making the best decision for the long haul.