The scramble that many startups make to secure venture capital funding may be detrimental to the budding business’s health.
In fact John Mullins, writing in Havard Business Review’s blogs, makes the point that the vast majority of successful entrepreneurs never take any venture capital (his italics). Mullins is an associate professor at London Business School.
He gives examples from around the world, but the observations are almost undoubtedly true about New Zealand too.
He quotes venture capital investor Fred Wilson of Union Square Ventures.
“The fact is that the amount of money startups raise in their seed and Series A rounds is inversely correlated with success. Yes, I mean that. Less money raised leads to more success. That is the data I stare at all the time.”
Wilson’s observation demonstrates there are a number of serious downsides in raising capital too early, and that these drawbacks have profound implications at all stages of the investment cycle. I’ve summarised the five drawbacks to VC funding made by Mullins, who also provides some interesting links supporting these arguments.
1. Pandering to VCs is a distraction.
Raising capital demands a lot of time and energy, when an entrepreneur is better off convincing prospective customers to buy – or perhaps learning why they won’t.
2. Terms sheets and shareholder agreements can burden you.
To protect their own downside risk, investors will require what are often seen by entrepreneurs as onerous terms.
3. The advice that VCs give isn’t always that good.
Unfortunately, entrepreneurs will be very likely obliged to follow the VC’s sage ‘advice’.
4. The stake you keep is small – and tends to get smaller
If money is raised later in the entrepreneurial journey, with customer traction in hand, the startup owner is in the driver’s seat, and is much more likely to find a queue of investors outside their door.
5. The odds are against you
In the VC game the very few winners pay for the losers, so most VCs are playing a high-stakes all-or-nothing game. Such odds make it extremely questionable whether entrepreneurs should put their own business into such a play.
Mullins’ take home point is that especially in the early stages, a startup business is much better off being funded and grown entirely by its customers’ cash.
Outside funding is not the be all and end all – though it can quite easily be the unintended end of the startup.
The article also has some excellent comments (as you’d expect for a HBR type article which add further insights to Mullins’ observations).