Advice

Venture Capital Money: The Most Expensive Way to Finance your Business

No technology misconception is more pervasive than the one that entrepreneurs should turn to venture capitalists for funding. I’m not sure how seeking out venture capital investment came to be the default logic for entrepreneurs. Venture capital funding for start-ups is not the win-win situation many imagine, rather it’s a slow bloodletting.

And there’s no reason for it.  Unless you’re starting a major manufacturing business or competing in some industry that has a major cost barrier to entry (in which case you should probably reevaluate your position about starting that business anyway) it’s not that expensive to start a business.

For income, a company that took just five years to grow into a $100 million plus revenue business, it took the six co-founders $50,000 each of initial funding.  We probably could have secured money from venture capitalists, but we didn’t even consider it.  Instead, we built the company the way we wanted and didn’t have to share the profits with anyone.

In short, venture capitalists do not have entrepreneur’s best interests at heart.  For one thing, VC firms are among the biggest proponents of companies over-reaching, spending money to create publicity and buzz and not bearing down to build a successful revenue model.

Why?

Because venture capitalists are flippers.  They are not looking to stay involved in the business forever and to get rich off its profits.  Quite to the contrary, they are looking to acquire part of the company and then sell it for more money later.  That, or gain enough of a vested interest that they can cash out via an initial public offering.

The root of this problem is the venture capitalist business model. VCs will invest in twenty companies with the hope that two of them hit it big. While first-time entrepreneurs are happy with singles, VCs force them to swing for the fences. With VCs, the mantra is “go big or go home.”

And, the VC business model manifests in a number of problematic ways for the entrepreneur.

After a VC firm invests in a company, typically there will be little attempt to create a working revenue model. Keep in mind also that it’s still the exception to find someone at a VC fund ­ such as a Marc Andreessen or Reid Hoffman ­ who has actually taken his own company from nothing to a $10 million, $50 million or $100 million-plus annual revenue business.

Additionally, in an effort to sell or take the company public quickly, VCs often will push the entrepreneur to scale the business much faster than is necessary.  In addition to diluting your share of the company even further, you will find yourself having to hire and manage scores of new people who aren’t truly necessary to the success of the business.

The only times a company should ever accept venture capital money is when a) it’s a choice between accepting the money vs. going out of business or b) there’s no other way to grow further without a cash infusion.

That said, if you are in need of early-stage outside financing, here are three alternatives to taking VC money:

  1. Angel investors and crowdsourcing: both will have different time frames from VCs who are impatient for growth. Regarding the latter, there are currently hundreds of crowdsourcing platforms ­ such as Kickstarter and Indiegogo ­ from which an entrepreneur can raise money from Individuals.
  2. Suppliers: if your suppliers value your product, they will want to do whatever they can to keep you in business, including being the source of a loan.
  3. Customers: ask them to pay in advance for the services you will deliver in the future. If your customers believe in your product and your business, they will be very open to this arrangement, providing you with much needed cash.

An entrepreneur, or set of founders, should always strive to maintain complete control over the company until they have figured out how to execute the idea, turn a steady profit and grow.  Then it might be reasonable to take VC funding or to sell a stake if a cash infusion is absolutely necessary.  Under those circumstances, the mature company will be able to dictate terms, chart the company’s strategic growth and choose with whom they want to work.

This guest post is from Naveen Jain.

Image/Freedigitalphotos.net

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Gresham Harkless Jr.

Gresham Harkless is a Media Consultant for Blue 16 Media and the Blogger-in-Chief for CEO Blog Nation. CEO Blog Nation is a community of blogs for entrepreneurs and business owners. Started in much the same way as most small businesses, CEO Blog Nation captures the essence of entrepreneurship by allowing entrepreneurs and business owners to have a voice. CEO Blog Nation provides news, information, events and even startup business tips for entrepreneurs, startups and business owners to succeed.

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One Comment

  1. Las Vegas is a hotspot right now for Angel Investors and new start ups looking for cash. A lot is centered around the downtown project catering to new tech start ups, but there are also a lot of other types of companies getting in on the action.

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