(Editor’s note: Chad Little is the founder and CEO of FetchBack. He submitted this story to VentureBeat.)
Over the course of my career I have done the bootstrap venture, the venture with significant VC dollars and the capital efficient venture (sub $5 million). Through all of these experiences I’ve learned lessons about capital raising, and more specifically, the cost of doing a large VC round. I’m not about to claim that VC money is always a bad idea, but before you take your startup on a tour of Sandhill Road, here are five reasons NOT to accept the big paycheck.
You’re the rule – Let’s acknowledge this and get it out of the way: Occasionally there’s an exception as to when it’s smart to raise a large VC round. Most startups that go after this kind of capital are not in that camp.
A great example of this is when a company is perfectly positioned, has a proven model and by “throwing gas on the fire” it can move to dominate a position in a marketplace. These are the stories we read about when the big hit occurs. These deals are the exception, not the rule, but they’re the ones that get the majority of press and attention.
I have, unfortunately, witnessed too many times where entrepreneurs are faced with the decision to do a large VC round and fall victim to the fear that they have to pull the trigger in order to be competitive. The thought rings through their heads, “I have to fill the coffers, if I don’t they’ll pass me by!” This is a false belief and the fear alone leads many entrepreneurs into bad decision-making. The majority of the deals getting funded today by large VC rounds do not fall into this category.
It creates a false sense of security – There was a company during the course of our first year of business that I was convinced would be a key competitor – especially if they should get significant traction. I knew the company was pre-profit, had a hand-full of clients, and was beginning to show promise. Then it happened. Their major round of capital came in.
They weren’t ready, though. This wasn’t a company that had discovered the next big thing and was ready to explode. It was a company that had promise and was being approached by VCs left and right.
When you throw this much money at a company in this stage it can create a false sense of security, make management lazy, and unfortunately set up a series of events that take the founders out of the game. In this case, that’s exactly what happened. (I’ve made the same mistake as well in the past.)
It’s just money – The promise that comes with money about added value is usually a false one. The reality is there’s a lot of capital out there chasing very few good deals. If an entrepreneur has a solid offering, getting cash is not an issue. Getting cash from a group that also offers connections and mentorship is another thing.
VCs who use lines like “The doors we can open,” and “The expertise we will bring to the table” should set off warning bells. And if you are in the minority that actually receives mentorship from your investors, know that this value can help a company that has already got momentum, but it cannot mask the need for the management team to properly execute.
Mismatched goals – VCs often conflict with management around goals. Most VCs are under tremendous stress these days to provide a positive return, based on fund performances of the last five years. This drive can often times be at odds with what’s right for the company and the management team long-term.
VCs are typically not in it for the long haul and if an opportunity presents itself to cash out early, it can cause tremendous strife if the entrepreneur is not ready. You run the risk with any outside investors, but additional pressures on VCs to create returns can increase the chances. This venture is your baby. Really consider if you’re okay with someone else calling the shots.
Redefine success – It’s easy to equate success with getting a big round of financing completed. No question it’s a major achievement. But when you look at the dilution that you had to accept, a different thought may go through your head: “Why did I give up that much of the company?”
I equate happiness with having options. The scenario of big round, after big round and the gradual dilution of shares is just one path to exit. Here’s another: Prove out the model. Prove out the product, even if at a minimal level. Keep expenses tight. Don’t over extend. Don’t get caught in the “I must do a raise to compete” mode.
If you can meet these milestones, this is true success. It’s when you get here that you realize you can keep more of your company than you initially thought possible, and you know you can get the job done with fewer resources.