We’ve all read the headlines:
SaaS Startup Raises $100M in Venture Capital to Disrupt Market with Its Innovative Solution
It seems so common, but is it really?
Venture capital funding is to tech startups what the Wizard of Oz was to Dorothy. Revered for its seemingly magical superpowers that promise a happy ending, venture capital (VC) is often seen as the secret to startup success, even though the real power to make your dreams come true lies within you. Just as Dorothy discovered the wizard was a charlatan, founders similarly reach the end of their journey only to realize what’s behind VC’s smoke and mirrors.
Founders often wonder: Is venture capital worth it?
Venture capital funding is a high-risk, high-reward game. The prestige and publicity that come with raising funding from VCs makes it all the more alluring for founders.
Not all startups need venture capital, though. Only a tiny fraction of startups benefit significantly from a massive injection of upfront venture capital.
Raising venture capital is ideal for startups entering large, competitive markets that need to win market share quickly or develop IP. Of course, millions of dollars in upfront capital might help a startup disrupt a market, but it’s still only a resource to help accelerate research and development, sales, marketing, and other aggressive growth essentials.
For many startups, bootstrapping — growing under your own steam [RR1] (revenue) without selling equity and control of your company — is the best option.
Before you follow the yellow brick road, consider these six VC disadvantages to decide whether venture funding is the right fit for you and your startup.
6 Disadvantages of Venture Capital for Startups
1. Venture capital is absurdly hard to secure.
Stories of startups that raised VC funding seem to dominate financial headlines, but in reality only about five in 10,000 startup businesses receive venture funding — less than 0.05%, according to Fundera. To put that into perspective, a professional golfer has about the same odds of getting a hole-in-one during their career (according to the National Hole-in-One Association) as you do of getting funding from venture capitalists.
If you don’t need a massive injection of capital to reach your next milestone, your time will be better spent cultivating your business than chasing after VC investors.
2. Raising venture capital is time-consuming.
To boil it down, it’s a sales game; you’ll spend a huge amount of time researching, prospecting, booking meetings, pitching, answering questions, and negotiating. You might have to contact 300 or more VCs to book just a handful of meetings. The hours upon hours you’ll spend with those VCs still do not guarantee success. Ultimately, all that time away from your core business is more than a distraction — it’s a drain on resources, revenue, and business growth.
Furthermore, VCs might take the meeting or accept your pitch deck simply to educate themselves about your product or category — with zero interest in investing. It’s beneficial for the VC, who can then better identify the team and solution they feel is most apt to succeed; for you, it’s a massive waste of time and resources, and it could spawn competition.
3. Venture capital is expensive.
Congratulations! After hundreds of hours of prospecting and meeting with VCs, you catch a break. You get a term sheet, the excitement builds, and you think, “We’re on our way to success!”
Not so fast. What does the term sheet say? Who’s setting your valuation? Are you getting a fair deal, and could it be better?
Remember, a term sheet is a contract crafted by the VC’s legal team and serving their interests. VCs want the most equity at the right cost, which could mean a lower valuation for you. To further protect their equity investment, they might add clauses that can hamstring your ability to raise capital in future rounds such as specific milestones or achievements you must reach before raising another equity round.
There are almost always important details outlined in term sheets that, if overlooked, could cost you and your team millions of dollars.
Scott Sehon, CFO of Numerical, learned what VC would have cost the company in equity when he found alternative funding to keep growing.
“We would have paid $3 million for that $1 million of equity. That’s really what it would have cost us, compared to the incredibly reasonable terms we got with Lighter Capital for the same investment.” — Scott Sehon, CFO of Numeracle
4. VCs demand a lot of control.
VCs have one objective in common: getting the highest investment return. Most of the time, VCs bet on you and your team leading the charge to achieve the desired results, but that’s not always how it plays out.
When you take on equity investors, you’re getting business partners who might demand a say in the business operations and strategy. If they require a seat (or multiple seats) on your board, prepare to give up significant control over the direction of your business.
VC money always comes with a catch.
You could end up working with a third party who has contrasting views about your company’s future and almost invariably doesn’t know your business or market as well as you do. In the absence of a strong symbiotic relationship, your investor could exert their power to seize control of the company.
Finding yourself on the other end of the spectrum with a zombie VC fund that’s overexposed and closing up shop isn’t going to do you any good, either. So, don’t take VC money without evaluating your return on their investment.
5. VCs need an exit.
A VC’s timeline for achieving the return on their investment might not align with yours. You might want to build value and sell the business in 10 years, while your VC partner needs a 2X return in five years.
Which outcome is better? The answer depends on which side you’re on.
Your ownership value at exit 10 years from now with healthy, sustainable business growth is probably far greater than it will be in five years. VCs, on the other hand, have other incentives that might necessitate an earlier exit, such as urgency to generate a return for the investors of their funds, or a change in the market’s appetite for companies like yours.
It’s not unusual for VCs to put clauses in their term sheets that specify if and when a sale can be considered, even if you don’t agree it’s the right time to sell your startup.
6. Uncertainty spooks VCs.
Many people mistakenly believe VCs are high-risk gamblers. Like any investor, VCs love huge returns (which they always talk about), but for every big win, they incur multiple losses (which they keep close to the vest).
The National Venture Capital Association reports about 30% of venture-backed businesses fail. Shikhar Ghosh, a senior lecturer at Harvard Business School, says his research shows about three-quarters of venture-backed firms in the U.S. don’t return investors’ capital.
Venture capital professionals might spend most of their time reviewing pitch decks from entrepreneurs and finding startups to invest in, but their primary goal is to minimize the impact of losses on the entire portfolio’s return. Anything that increases the possibility of a loss is a good reason to sit on the sidelines, even with available capital to invest.
Timing is everything. VCs have a firehose of information on market conditions, emerging technologies, and comparable companies, which can upend their interest in your company in a heartbeat. They might be over the rainbow about your potential one day and sending you back home to Kansas the next.
VC funding can be elusive, which further imperils your investment of time and resources into raising venture capital.
Finance and Grow Your Startup Without VC
Though VC funding can be the right fit for some startups, it’s important to ask yourself whether it’s the right fit for your startup. Countless founders take a pass on VC funding because of the cost, the risks, and the many strings attached to it.
Bootstrapping your way to success might be the best strategy for you and your startup. Today, you don’t have to put all your savings or personal assets on the line, either. You could grow your tech startup with the revenue you are making, or you can instead use that revenue to secure non-dilutive growth capital so you can scale faster.
Lighter Capital has helped more than 400 tech startups grow their businesses — without selling their equity — for more than a decade. Unlike venture capital, our non-dilutive startup capital will:
Keep equity and control of the business in your hands,
Minimize the time you’ll spend trying to raise capital; and
Provide the same support and networking benefits you’d get from a VC partner.