Which Type of Financing is Right For You? The Pros and Cons of Venture Capital

September 16, 2016

Having a great idea for a business is one thing. Getting the financial backing to grow, scale and make it a success is quite another.

Most entrepreneurs approach funding in stages, starting by dipping into their own savings, going cap-in-hand to friends and family, taking advantage of government grants, crowdfunding and potentially seeking angel and venture capital.

The best funding option depends on the business, its track record and growth plans. Some companies stay self-funded forever, while others need the capital injection and expertise from outsiders. Getting the right investment, in the right sums at the right time can often make the different between a startup’s success or failure.

Techvibes has put together a list of common investment options for startups, and pros and cons for each. It will cover the following:

Venture Capital

If you’re at the stage of seeking venture capital (VC) for your startup, congratulations, you’re making things happen. VCs are deep-pocketed investors who put their money in startups they believe have the potential to scale, quickly. Of course, there’s no guarantee anyone will wind up getting rich from your business idea, but you’re on the right track.

VCs tend to make much larger investments than other forms of funding. Of course there are some pitfalls to watch out for. Below are the pros and cons of VC funding:

Pros

Deep pockets: VCs have serious money to help grow your business. The average investment is usually between $500,000 and $5 million, according to Entrepreneurship.org. That’s the kind of money that can supercharge sales. What’s more, it’s your money. As this QuickBooks blog notes, VCs are gambling on your business.

“If it succeeds, they win big; if it fails, they eat their losses.” That’s unlike a bank loan. “If you go under, you won’t have investor debt hanging over your head.”

Experience: VCs are usually experienced entrepreneurs and investors.

“It’s ‘smart money,’ which means they are a member of your team, effectively,” says Mike Woollatt, CEO of the Canadian Venture Capital & Private Equity Association (CVCA). You not only get advice from people who’ve built and sold successful companies in the past, but also active mentorship around how to overcome challenges and setbacks. Remember: VCs have a vested interest in ensuring your startup succeeds.

Valuable connections: With experience comes connections, says Woollatt, especially in your particular industry. For example, a tech-focused VC will likely have a broad network in tech hubs such as Kitchener-Waterloo, Toronto, Vancouver or Silicon Valley. Those connections can turn into investors. Who knows, one of them may even be a buyer of the company down the road — if that’s your end game.

Cons

You have to really hustle, then wait: You thought starting a company and getting it up and running was a lot of work. That’s nothing compared to finding the right VC partner.

“As the entrepreneur, you’ll have to prepare thorough business plans with financial projections, power point presentations and even seek third party counsel to make your proposal more compelling,” notes Los Angeles-based GrowThink in this blog. “Once you’ve created these deliverables, you’ll have to network and contact the right venture capitalist that invests in your sector.”

It could also take time for them to decide if they want to invest in your startup. Entrepreneurship.org pegs it at six months to a year. Business owners who don’t possess the patience of a saint may find that wait excruciatingly frustrating,” they note.

The pressure is on: VCs have high expectations for your business and the money they’ve invested in it. Unlike your parents who, if you’re lucky, may offer a few thousands bucks to help grow your startup, VC funding isn’t love money. It’s all business.

Expected rates of return can be as high as 50 per cent annually, Entrepreneurship.org warns.

Loss of equity/control: In most cases, a VC investment includes equity in your company. That’s not necessarily a bad thing, especially if those equity holders can help grow your business. Problems usually arise when there’s a disagreement between founders and VCs on the future direction.

If it gets really nasty, and depending how much equity you’ve given up, you may wind up losing control of your own company.

Takeaway:

VC funding is a blessing for many startups — and a sign of success. If you’re attracting VC money it means you’ve got a product or service that has potential and could make you — and your investors — rich. But that dream could collapse if you don’t find the right VC team that shares your vision. Don’t just be interviewed by VCs, do your own interviewing.

If you want to learn more about what VCs want, here’s an interview McKinsey did recently with Steve Jurvetson, a partner at Silicon Valley-based VC Draper Fisher Jurvetson, titled “Inside the Mind of a Venture Capitalist.” Here’s a hint: They like crazy ideas, infectious enthusiasm and anything that disrupts old-school business models.