Venture capital funding is a valuable tool that can take startups to the next level. There are times, however, when it might not be the best choice, and in these cases, it may prudent to wait for more favorable circumstances or to seek another route to success.
The Clock Starts Ticking
Most of us have heard the statistics regarding the bleak prospects for startups that don’t survive their first five years, but what is repeated less often is that great brands often require a longer incubation period. We think of such iconic products like Coca-Cola and readily accept that it took time to reach such celebrated status. Put simply, greatness doesn’t always spring up overnight.
Unfortunately, this doesn’t bode well for taking a venture capital approach, as there is an expectation on return on investment or ROI within ten years’ time. Most agreements provide funding within the first three years, infusing a startup with additional monies throughout the lifetime of the partnership.
It must also be remembered that even when a company does experience growth within that timeframe that they may be competing against older and more established offerings in the marketplace. This can present a challenge in the race to become profitable. If you believe your idea is one that may take longer to mature, seeking venture capital investors may add an undue burden to that process.
Too Much Of A Good Thing
It is crucial to calculate the proper amount of money to raise, and this should ideally be tallied as 18 months of operating expenses plus 25% as a cushion. Unfortunately, many startups make the securing of funds their goal and give little thought to the fact that a windfall can prove fatal to their corporation.
To begin with, the priority should be on the creation of a superior product, service, or idea and not courting investors. Startups need to remain rational and not become so desperate to enter into a partnership that they do so on bad terms.
When too much capital is raised, the expectations of ROI will be commensurate with the amount invested, putting intense pressure on the company. Founders may end up diverting funds to multiple projects without a clear and sustainable path for scaling and maintenance. In addition, the burn rate may increase, further ensuring a downward spiral. Workers may be spread between more channels, focusing their energy in scattered ways.
It requires a great deal of discipline to enforce measured spending in the same way as when a company was short on cash and still struggling. Instead, seek the funding needed to get to the next stage before assessing whether more is truly needed.
More Cooks In The Kitchen
Inviting a venture capital firm into the fray means that you will have others at the table whose desires will now need to be considered. Each investment team will their own set of goals and vision for what they want to accomplish, and they each will have areas in which they will specialize.
Due diligence is crucial prior to partnering, and you’ll need to understand how the fund is incentivized on the side of the venture capital, as this is often based on size and various dynamics. Be certain that the objectives for both your company and the investors will dovetail, as your ship may be headed for the rocks if these principles do not align. The board will be legally required to incorporate the venture partner’s wishes, and you may be pushed in a direction that is good for your investor but that does not benefit you.
Fidelman & Co. specializes in management consulting, presentation advisory, and financial modeling. We focus on building businesses alongside entrepreneurs and investors. Contact us today for more information about what we can do for you.