What Nobody Tells You About Taking VC Money
With worldwide venture capital activity for 2016 down by 24 percent -- and total deal funding down from $141 billion in 2015 to $127 billion in 2016, according to a KMPG report -- seeking venture capital has become a lot like playing the lottery. A lucky few strike gold, but most go home empty-handed.
Of course, raising VC funds makes sense in certain scenarios. Entrepreneurs frequently cite guidance and support as major reasons for taking such capital. VC investors are typically subject-matter experts who know where the industry is headed and what its consumers value.
But the VC route doesn’t just bring knowledge and capital. VCs, through their work, are connected to similar entrepreneurs in the space. They can open doors to partnerships and talent that make rapid growth possible.
For many entrepreneurs, that promise of rapid growth is at the heart of their decision to take VC cash. Those in new or changing markets, for instance, need to capture market share as quickly as possible. In such situations, bootstrappers can’t compete. Canada’s Venture Capital & Private Equity Association, in collaboration with the Business Development Bank of Canada, found that over a five-year period, VC-backed companies posted nearly threefold greater sales growth, realized almost 50 percent greater employee growth and were 15 percent more likely to survive than their peers.
The hard truth about venture capital
To be sure, there are good reasons to take venture capital. But in San Francisco, where I live and run my business, everyone wants to be Mark Zuckerberg. Here, entrepreneurs are expected to raise VC funds, and its downsides are rarely discussed. Shows like Shark Tank make entrepreneurs think VC money works miracles for businesses, when in fact, less than 1 percent of companies are built that way.
With those realities in mind, my company chose not to take venture capital. We’re not trying to create a massive, fast-scaling operation, so we would have been of little interest to investors anyway.
If any of these three situations apply to your company, you should probably skip VC funding as well:
1. You’re starting a service-based company.
If your business is service-based, you’ll have no need for (and no luck) pitching to VC investors. My partner and I envisioned our company, Yeti, as a profitable business that relied on our technology-development skills. We knew it would never go public, and to this day, the acquisition offers we receive come from larger companies interested in our expertise or portfolio -- not investors looking to make millions off our brand.
The VC model works best for product-based companies poised for parabolic growth. At least for a time, these companies scale production without adding infrastructure and personnel. Service-based businesses, on the other hand, must grow their employment roster at a rate similar to that they grow their customers at. Such circumstances make service-based companies poor candidates for VC funding.
2. You can’t afford to pay back a high-interest VC loan.
Venture capital isn’t free money. If you’re successful, investors want to see tenfold returns. If you’re not, they may recoup the funds by liquidating your company. VCs play a high-risk, high-reward game, so they rightfully want to be heavily involved in decisions about their investments’ growth.
Is that pressure bad for entrepreneurs? Not necessarily. On one hand, taking VC money can create financial wiggle room for cash-starved startups. Back in fall 2009, for example, WhatsApp's co-founders wanted to create an instant messaging app, but they struggled to scrape together seed funding. After partnering with Sequoia Ventures, however, WhatsApp turned its idea into an app that acquired a billion monthly active users and counting.
On the other hand, VC-backed entrepreneurs have little time to prove themselves and equally little say in structural business choices. Because we’re not VC-backed, my co-founder and I are free to explore business initiatives without a growth-at-all-costs mindset.
3. You’re focused on incremental growth in small markets.
Not every business is destined to become the next Snapchat or Twitter. In fact, most aren’t, and that’s okay. Many companies -- particularly service-sector companies or brick and mortar businesses in rural or suburban markets -- are best served by steady, linear growth.
Yeti is growing fairly quickly, but we’re nothing like VC-backed startups, which grow at 15 percent to 20 percent or greater monthly recurring revenue. We’re not taking over large markets, we pay people well and our growth rate is safe and profitable. We’re able to spend the time needed to tinker with new technologies while delivering great service to clients. All of that is by design. If we had VC backers, they’d be upset that we weren't on track to go the IPO route or get acquired any time soon.
Yes, our company isn’t growing like a VC-backed venture. And, yes, we’ve had to rely on homegrown networks and learn lessons the hard way. But we’ve built a profitable business, forged numerous partnerships and created a culture to reflect our values. And we've done it without VC funding.
So before you take money with outstretched arms, think carefully. Consider your growth goals, the importance of autonomy and the risks and rewards of VC investment. VCs may promise millions in startup capital, but vision for your business might not align.