Entrepreneur

5 ways taking venture capital could hurt you

Glen Hellman is the founder and chief entrepreneureator of Driven Forward LLC. This post originally appeared on his blog.

It’s every startup founder’s dream: Having a venture capital firm invest in your company.  Let’s celebrate! We’ve finally made it! We’re going to be big … right?

Well, most likely not.

First off, only 20 percent of venture funded companies are considered a success by their investors, and of those, not every company exits with the founding team intact.

Here’s a list of some of the unintended consequences of VC funding caused by the unnatural acts of mixing the needs of a VC with the realities of growing a company.

  1. Increased Difficulty of An Exit – When a founder raises big money at a high valuation investors inject funding terms like board control, preferences and participation to ensure that the founders are 100 percent focused on delivering a BFE (Big Friggin Exit). Investors want a 10X return and aren’t going to agree to a puny $10 million exit. There are a large universe of potential buyers in the $10 million range.  There are an order of magnitude fewer exits opportunities in the $50M+ range.
  2. Lower Return for Founders – You raised $5 million from investors. They’re targeting a $50 Million return (10X) for themselves. So now you found one of the few companies that can buy you and pay $50 million. Your investors most likely have dictated deal terms that either guaranteed that they will get a large portion — if not all — of that money or they will veto the deal. Founders may have to sell for $60+ million, a Herculean feat, to earn as much as they would in a buy-out of a bootstrapped company sold for a more easily obtainable $5 – 10 million.
  3. Less Flexibility – Your company has grown to $10 million in revenue and is creating $2 million in free cash flow. If you’re bootstrapped, you and your co-founder pivot to a lifestyle company and pocket a million dollars a year, not counting salary and bonus. If you’re venture funded and the company growth is stalled, you may get replaced. If you’re not ejected and your compensation committee (staffed by investors and not you) will insure your compensation is such that you need a big exit.  You won’t be pulling down the big bucks until the VCs get theirs.
  4. Pushed to a Half-Baked Exit – Venture funds typically have a 10 year life. VCs are focused on winding down the fund at the end of fund-life and exiting out of all investments. A three-year-old fund is going to push you to sell your company within 5 to 6 years of investing in you… whether the cake is fully baked or not.
  5. Purgatory – File this under “Crazy But True.” Sometimes a venture firm will keep a company alive, even when pulling the plug is the obvious and humane outcome. They’ll pare down the staff, cut the burn, and allow the company to survive long enough for other portfolio gains to outweigh writing off the loss of your brain-dead company. I’ve been the CEO of a company kept on life support, fed only enough cash to live another day and not enough cash to grow and thrive. I pulled my own plug from that painful life without dignity.

Keep in mind that closing a round of funding is just a stage in your company’s growth. It adds capital that can accomplish great things and it adds risk. Celebrating a funding event is like celebrating a team’s selection to NCAA basketball tournament. It’s not time to pop the champagne. You’re not the tourney champs yet. It’s tougher than the regular season because you have a lot of games in front of you and one loss by even 1 point knocks you out of competition.

Glen Hellman is a former serial entrepreneur and hired gun turn around CEO for VCs. Today he’s an Angel Investor, Executive Leadership Coach, and blogger.

Photo credit: TaxCredits.net


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