Venture Capital Financing: Pros and Cons

by Startacus Admin

"Financing a business is an important decision. Even if you have enough savings to launch your idea, it’s always better to diversify the investment to minimize your risks. Financing through venture capital, however, is quite an advanced step that requires a lot of thought.

Venture capital could be a good resource for both startups and established businesses, but only if the companies are able to provide a decent return. A venture capitalist or VC firm simply wouldn’t invest money in an idea they like; they look at whether the benefitting business would be able to make them a tidy income or not.

If you’re operating a business in high-tech industries such as renewable energy, IT, biotechnology, or healthcare, you would probably stand a high chance of being backed by a VC firm. However, you would have to fork over quite a large amount of company equity to the firm in question.

Giving up partial or even complete control is quite a risk, so be sure to weigh the pros and cons before signing the dotted line! If you’re still confused about whether this financing route is good for you, we’ll be talking about some of the pros and cons below.

Pros

Financing

The main attraction in a venture capital investment is that it’s not a loan. At the very least, the owner or manager of the business wouldn’t be obligated to pay back the money from their own pocket. That responsibility would fall directly on the company.

If your business fails even after the investment, the VC firm is the one that stands to lose out. It’s purely a gamble on the success of your business, not your personal integrity.

A Lot of Capital

Venture capitalists typically give a lot of capital to the companies and businesses they’re interested in.  If you’re operating a high-tech company, you would need quite a bit of investment in order to enter the market and be a competitor to reckon with. Since this is what VC firms want, they have to be prepared to pay the price of backing you. As a result, you get almost everything you need from a VC firm for taking your business to new heights.

Connections That Matter

If you’re connected to the right kind of VC firms, you can greatly benefit from their expertise and connections in the industry. VC firms take over a lot of control within the companies they invest in, and many small businesses could greatly benefit and expand under their guidance. At the end of the investment period, you may get a larger, more streamlined and established company than you started out with.

With the VC’s connections in the market, you can get in direct touch with angel investors, interested clients, and more parties that could help to boost your business further. Once you get into a good industry network, you would eventually be able to foster beneficial connections on your own.

Achieve Goals Faster

Once you get some seed funding as a startup, you can achieve your goals at a faster pace than if you were to struggle at every step. It’s important to get your idea out there before anyone else comes up with it. The amount of money, support, and guidance that you get from a VC could be the difference between making and breaking your lifelong dream.

Even if you think you can succeed on your own, having some decent capital in the beginning could help you skip years of development, saving, and losses. This is the most delicate part of a business, where an entrepreneur is most likely to give up. Going for VC investment could hence prevent many a talented individual or team from losing hope and exiting the market before they’ve truly begun.

Cons

Not In Control

As soon as you sign off on a VC firm investing in your company, you relinquish a significant part of control. This means that important marketing, production, hiring, and even selling decisions would be at the discretion of the VC firm. What the firm deems best would, in some cases, be the path your company would take, at least for the next five to ten years.

This loss of control may turn out to be financially beneficial for you, or it may destroy your company if the right decisions aren’t made. Since an inexperienced VC firm wouldn’t know the nuances of your company and wouldn’t be working with the same passion, they may even be the end of the company altogether.

Plus, you may have goals other than large profits, but not be able to follow through on them due to VC control. For instance you may need to hire five developers for a project, but this move could be vetoed by the ones in charge, as the VC firm could make the decision that this extra expense is unnecessary.

Lack of Discipline in Spending

When you get an injection of capital, you may be tempted to make some rash decisions. This could include unnecessary bonuses, extra purchases, and a tendency to not lay some money aside for a rainy day.

Budgeting skills are extremely necessary for a business team to develop, especially when the company is just starting out. If they get too much capital right away, it would be all too easy to get in the habit of spending freely. This could severely stunt long-term planning and growth.

Lack Of Attention

With a venture capital loan, a manager could be constantly distracted by the demands and interference of investors from outside. They would, in some cases, not be able to devote enough time to the daily workings of their company.

If the ideas of investors and managers clash, they could lose a lot of time and effort in trying to fight for their own priorities. If you’re fighting for what you believe in all the time, accomplishing your goals could very well take a back seat.

Possible Parasites

As mentioned above, it's important to find a sincere VC firm. If you’re new in the industry, it’s just as necessary to be aware of the reputation that certain investment firms hold. If you don't find out who to trust early on, you may very well find yourself in the clutches of a parasitic venture capitalist.

Firms like these would probably give you a hefty investment right at the start. However, they would demand more and more equity and control as time goes by, acting more as a leech on the company rather than a well-wisher. At the end of the agreed period, they would be able to free themselves of the depleted company and move on to the next one.

All this may sound a bit dramatic, but it’s happened. You can avoid such situations by taking a close look at the contract you’re about to sign. Hire a lawyer to look over any document before you sign or agree to it.

Above all, keep your eyes and ears open for what other companies are saying about this particular VC firm. It may be flattering that a group believes in you enough to invest in your idea, but you should be aware of their true motive.

Growing Too Fast

Even if a VC firm is sincere and does their best in making your company grow, stop and think if that’s really the path you want to take. At the end of it all, you may get a company that’s just too big for you to manage without proper help. You may end up being dependent on outside investors instead of fulfilling the dream of being your own boss.

Not Enough Guidance

While you may be afraid of too much interference, the other extreme is also possible. Some VC firms simply give their investment and their demands, then take a back seat and don’t offer any additional support. Of course, it doesn’t just take money to make a company successful. Without the proper guidance, connections, and networking, you’d be losing out on one of the main advantages of a VC financing source.

Conclusion

A relationship with a venture capitalist could be highly beneficial for your company. However, leaping before you look could potentially ruin your company and make it spin out of your ownership. At the end of the loan period, you may or may not be able to buy back your shares for a profit that satisfies both parties.

The main advantages or disadvantages of this financing method depends on the kind of company you’re running, the culture of your supporting VC firm, and your own goals. With the correct kind of analyses and predictions, the correct decision can be made. However, some disadvantages will always be there. Make sure you and your company are brave enough to power through and come out strong at the end of it all!

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Published on: 28th June 2018