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When should a startup not accept venture capital?

Jeff Andrews's Profile

Answers

Topic Expert
Bob Scarborough
Title: CEO
Company: Tensoft, Inc.
(CEO, Tensoft, Inc.) |

A few quick responses:
1) When you don't need it to meet your company objectives
2) When you don't want to for a variety of business reasons
3) When the return possibility doesn't fit the VC return requirements.

Diane D. White, CPA, CMA, MBA
Title: Principal and Business Owner
Company: Diane D. White, CPA, CMA
(Principal and Business Owner, Diane D. White, CPA, CMA) |

Bob's point #1 is also my #1. Never borrow money not needed. Additional thoughts, especially if you are small / new:

-- when you don't want to give up "that much" current owners' decision-making control (VC investors can be pretty intrusive)

-- when you can't, or don't want to, incur the additional expense of meeting requirements stated in the VC investor's proposed Operating Agreement (example: setting up a Board and running and supporting it according to whatever that agreement specifies....cost can add up fast, including mandatory audits you might not otherwise have planned on)

-- when the current owner's potential future equity position would be too diluted to make the pressure of dealing with VC partners worthwhile (this is subjective, naturally)

Good luck!

Topic Expert
Simon Westbrook
Title: CFO
Company: Aargo Inc.
( CFO, Aargo Inc.) |

I agree.
But a start up should be looking for all sources for raising investment, grants, friends, personal funds, angels, strategic partners, as well as VCs. The best source may depend on how much you intend to raise, what level of business and profitability you have reached, expectations for exits etc. It has been really tough to raise money over the last few years which is why VCs are looking to reduce their risk when they invest in your start up. That means imposing tough conditions on you. Remember, no matter how tough the terms, investment may be the only way forward, and a significantly diluted position in a succesful business may be better than owning a 100% share of a business that is going nowhere.

Topic Expert
Michael Bateman
Title: Principal
Company: The Bateman Company
(Principal, The Bateman Company) |

In addition to all the above, VCs fund looking for a big exit. If you are planning a "lifestyle" company, it would be disingenuous to take VC money (if they are foolish/incompetent enough to invest) and you'll have a difficult relationship with the VC. The benefits of VC funding in addition to dollars include: 1) a VC will normally lead the next round if you execute well enough; 2) a VC will help syndicate additional VC investment on subsequent rounds; 3) VC backing makes it easier to raise debt and at more favorable terms; 4) good VCs are helpful mentors (can vary Partner to Partner on your board) and 5) they may prove helpful for M&A or an IPO. Keep in mind that your goals and the VCs may not align over time as they are looking for multiples in various time frames to satisfy their Limited Partners (Investors). You might to hold for an IPO, they might want to sell the company. They might abandon you it not satisfied with your progress -- a bad signal to other potential investors.

david waltz
Title: Assistant Treasurer
Company: Integrys Energy Group
(Assistant Treasurer, Integrys Energy Group) |

Also, while most won't invest if this is the case, in a situation where they cannot provide any added value other than funding.

John Argo
Title: Consultant
Company: Independent Advisory Services
(Consultant, Independent Advisory Services) |

Always scrub the non-monetary terms carefully with a general counsel experienced with venture capital. How do the terms offered compare to other deals being done? These can have a much bigger or more lasting effect than valuations. How does the funds' portfolio, expertise, and connections help you? What is the age of the fund and how does that map to your exit roadmap? Who do they co-invest with (lead or follow)? Will that box you in when looking for additional capital? If it's only the money, then the deal will be problematic for everyone. Also check out thefunded.com.

Christine Russell
Title: CFO
Company: Evans Analytical Group (EAG)
(CFO, Evans Analytical Group (EAG)) |

I am a big fan of VCs and have had great luck through several start-ups. The key is to make sure you are at a stage to get the best valuation possible, meaning get some revenue momentum first and then invite some selected top quality VCs to come meet you. They have great rolodexes and can help grow the business more rapidly than you can alone. Make sure you actually like them.

Karl Sjogren
Title: Blogger & Consulting CFO to startups & t..
Company: The Fairshare Model for Crowdfunding
(Blogger & Consulting CFO to startups & turnarounds, The Fairshare Model for Crowdfunding) |

Good question and several insightful responses!

Of course, if you need capital and VCs are not an option that you like, what alternatives should be looked at?

There surely are investors who do not have the ROI requirements that a VC fund has. How does one get before them? A broker-dealer? An investment adviser with a high net worth client base? An angel investor funding group (or funding portal)?

Greg Kading
Title: Principal
Company: Gregory Kading LLC
(Principal, Gregory Kading LLC) |

There is really two questions that should be answered separately:

When should a start up accept or not accept financing?

If answer to above is accept financing, then what type of financing (and from what type of investor) should be pursued?

If you do decide to pursue financing, the VC route is really only available for very high growth businesses that are scalable and have clear path to liquidity for VC investor in 3 to 5 years and probability of providing 25%+ROI to VC investor.

If your business is not high growth (in other words 25%+ ROI is not probable, but maybe 15% is probable), then look for investor that is comfortable with that type of risk/return profile.

Most important discussion when accepting financing is trying to gain alignment of vision/objectives between management and new investors (and previous investors if you have already taken on). VC's are going to be driven to obtain high returns, and if it becomes clear that those high returns are not possible, the motivation changes to cut the losses.

Dan Christ
Title: Business Founder/Owner/CFO/Board Member
Company: Sundial Market Research & Loring Smart R..
(Business Founder/Owner/CFO/Board Member, Sundial Market Research & Loring Smart Roast) |

My only counsel in working with VCs for the first time is to anticipate that despite all the advice you are going to get about how to "present" properly your business model and growth plans, don't spend too much time in the verbal preparation phase since you will be interrupted constantly, and the focus of the inquiries will be almost entirely on IP protection, current and future market share and short-term sales growth. In the latter regard, all discussion will center around proof of demand. So, you had better have that down cold in every objective way possible.

From personal experience, I have found the private equity route to be much more inviting and fruitful for start-ups, though VCs certainly have their place. But for the latter to be true your business model should be far closer to the cure for cancer than your average run-of-the-mill start-up.

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