5 Reasons Venture Capital Is Bad For Start-Up Businesses

Getting venture capital used to be the focal point of an easy way out of investment woes, while ensuring fast business growth. For the longest time, aspiring start-up owners have been wired to believe it’s all about convincing investors of their venture’s massive potential for success through rock-solid business plans based on proven business processes and systems. All things considered, however, the odds may in fact be against startups and it may not be worth risking the new business to it.

Citing statistical data, Fred Wilson, venture capital investor at Union Square Ventures, points out compelling reasons why start-ups may need to rethink VC investment. He underscores how the money raised by start-ups “is inversely correlated with success” which means “less money raised leads to more success.”

“There are a number of serious drawbacks entailed in raising capital too early, drawbacks that have profound implications at all stages of the investment cycle,” Wilson said, spilling the details to Harvard Business Review:

1. Pandering to VCs is a distraction. Why spend your time trying to convince investors to invest, when you could spend the same time convincing prospective customers to buy — or perhaps learning why they won’t — before you burn somebody else’s money!

2. Term sheets and shareholders’ agreements can burden you. Investors don’t risk any better than you do. To protect their downside, investors will require what are often seen by entrepreneurs as onerous terms. And when the concise prose of the term sheet is fleshed out into the fine print of the shareholders’ agreement, the terms get even worse.

3. The advice VCs give isn’t always that good. Incredibly, nearly one in five VC funds actually delivered below-zero returns. Given this performance, you would be forgiven if you wondered just how helpful most VCs’ support or “value-add” is likely to be! Unfortunately, you will very likely to be obliged to follow their sage “advice.”

4. The stake you keep is small — and tends to get smaller. If you raise money at a somewhat later stage of your entrepreneurial journey, you’ll find that many of the drawbacks have largely disappeared. Why? Because with customer traction in hand, you’ll be in the driver’s seat, and the queue of investors outside your door will have to compete for your deal.

5. The odds are against you. Even worse, perhaps, than the difficult terms, the questionable advice you may get, and the dilution you will incur if you raise capital too early, are the difficult odds faced by companies that do win VC backing. In the typical successful fund, on average only 1 or 2 in 10 of the portfolio companies — the Googles, Facebooks, and Twitters of the world — will actually have delivered attractive, and occasionally stunning, returns.

Photo by 401(K) 2012

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