Raising millions through venture capital funding allows startups the luxury of rapid growth and not having to worry about how the bills are getting paid. In addition to capital, you gain partners who are connected and have enjoyed large-scale success. But there are downsides to venture capital that you need to consider before starting the process or inking that term sheet.
For example, venture capital is often very expensive. On average, startups will dish out over 25% equity stakes and term sheets will likely include the following conditions:
- Anti-dilution protection. They get additional shares for free if your valuation goes down in the future.
- Liquidation preferences. They get their principal and dividends back before anyone else gets money out.
- Mandatory redemption. This establishes a deadline for an exit event, putting pressure on you to have success in a pre-defined time period.
- Approval rights. They will want final approval on any new funding rounds and will have the right to participate.
- Reps and warranties. You’ll have to accept personal liability for representations you’ve made about critical aspects of the business which means they could sue you one day.
When you get in business with a venture capitalist, you need to understand that they’re going to have a large degree of control on your business and will likely demand board seats as a funding condition. You need to be super comfortable with their partners weighing in on your business decisions and operations. In the good scenarios, this is great, you have a funding partner who will take steps to guide you to success.
Finally, venture capital is not easy to obtain. While it might seem like an easy answer to your funding requirements, you are going to spend a great deal of time and energy pursuing venture capital and may end up with nothing in the end. Venture capital firms typically only invest in opportunities that are highly scaleable and have tremendous growth opportunity.
Some alternative options to venture capital funding:
- Angel Investors. Find an individual investor, a rich uncle, someone who knows you and has faith in you and your startup. These types of investors should be easier to work with and will cost you less equity wise. You can connect with thousands of angel investors and learn a lot about the process at angel.co
- CrowdFunding. A growing option for many these days is using crowdfunding to fund your venture. Check out sites like kickstarter, IndieGoGo and GoFundMe. To see a list of the top 100 crowdfunding websites, check out this useful page from CrowdFundingPR.
- Bootstrap Funding: Credit cards, personal loans, your paycheck. It’s not the sexy option and funding will always be an on-going concern, but many successful entrepreneurs will advice you to only take funding when you absolutely need it. Try to get as far along on your own which builds your value and increases your leverage when you finally do seek funding.
- Equity for Services. If you have a startup with some real potential, you may be able to exchange equity for a lot of the services that you’re raising funding for. Web development, lawyers, accounting firms, all of these are potential partners who may take equity in exchange for professional services. And if should cost you less equity vs traditional funding.