Why VC might not be right for your business

June 19, 2020

Venture capital is probably the most glamorous, aspirational way to fund your startup. The big marker of success for many entrepreneurs has gone from making profits to swelling your valuation with VC rounds! 

At Outfund, we find that approach a little misguided.

Let’s be clear: venture capital can be an amazing way to set up your business. For instance, we at Outfund are proud to be supported by a fantastic VC firm, Fuel Ventures. That makes sense for our business: we needed seed capital to build our technology and risk management systems before we could even think about revenue. 

But for a lot of businesses with cash-flow baked in from nearly day one, VC might not be the right choice to keep scaling. 

Here are some of the reasons why.

The upside loss

This is the core issue with growing purely through VC - it can mean giving away a lot of shares in your business. Yes, you get money with no obligation to pay it back. But you’re also giving away the long-term upside of your hard work. 

As an entrepreneur, your assumption has to be that your time and effort is building something that will be much, much more valuable in the future. From that perspective, while it seems cheap in the present, equity is the single most valuable thing you can give up in your business. Some of the most successful businesses in the world went public with their founders only owning a relatively small fraction of the company at that point. They still hit it big, no doubt, but if they had had the option to get the same funding without giving up the shares, it seems pretty likely they would. 

Long negotiations

Raising a venture round is an involved process with lots of pitching (that often goes nowhere), networking and negotiation. As a founder, your attention should be on growing and managing your business - it’s crazy the number of entrepreneurs who can spend almost an entire quarter focused on meeting investors and raising capital. Meanwhile the business you’re trying to sell a stake in might be going off the rails for lack of attention.  

Complex clauses

Here’s an introduction to two concepts you really need to know if you’re looking at VC.

Ratchet: A mechanism where if a VC firm invests at a certain valuation and then the company has to raise more money at a lower valuation, the first VC firm has their investment adjusted to the lower price i.e. gets extra shares. 

Liquidity preference: A mechanism where certain share classes have superior rights during sales or IPOs so that owners of those shares will get a pre-agreed return before other investors can be remunerated. 

These are very standard clauses that VCs use to protect their investments, but they’re not particularly founder-friendly. They reflect the fact that VCs are often holding most of the cards when they negotiate deals. To be totally fair, this is because VCs have a responsibility to their investors to safeguard their money as much as possible. That’s their priority. 

But the fact remains, VCs are rarely invested on the same terms as you: they get more of the reward and less of the risk. Why take that deal if you don’t have to?

Addicted to cash

This is more driven by how many businesses behave when they’re purely VC-funded. When business receives what feels like strings-free cash, along with the expectation that they level up their company to future unicorn status, it’s pretty easy to start spending like crazy. Whether pursuing inefficient growth, going on hiring sprees or just fancy offices and high expenses, companies can become very sloppy and undisciplined when their business becomes detached from real cash-flow.

Funding with VC doesn’t make your company less efficient, but it can certainly help create a more reality-free, consequence-free environment.

Venture capital has been and will be around for a long-time and we certainly don’t dispute its vital role in the startup ecosystem. However, if you’re an online entrepreneur with a post-revenue business, you might want to consider funding that drives your growth and revenues, while keeping you firmly in the driving seat. We’re happy to help you with that!