Start-up entrepreneurs need to keep the old adage; “be careful what you wish for” in mind, when dealing with venture capital. Instead of being a godsend, a lot of the venture capital out there is actually a very bad deal for entrepreneurs.
Despite all the hype about unicorns and the billions of dollars pouring into companies like Uber Technologies Inc.; the venture capital market could actually be more dangerous than ever for novices. Some of the new dangers are outlined in an excellent blog post from Silicon Valley capitalist Bill Gurley.
“While not obvious on the surface, there has been a fundamental sea-change in the investment community that has made the incremental Unicorn investment a substantially more dangerous and complicated practice,” Gurley warned. Gurley demonstrates how venture capital can become a trap that can lead an entrepreneur astray.
He thinks the unicorn process has effectively become a treadmill; in which entrepreneurs spend all their time trying to raise capital and please investors – rather than tend to their businesses. If Gurley is correct, venture capital could actually be destructive to many startups.
The Dangers of Venture Capital
Venture capital actually poses some serious risks to startups that many entrepreneurs do not learn about until it is too late. Some of the greatest dangers include:
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Raising venture capital; and not running or building up the business, becomes the main activity of the startup team. Instead of developing a product that works, or an effective business plan; the entrepreneur spends all of his or her time raising money.
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Control of the business could pass to the venture capitalist.
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Cash flow gets neglected. Many entrepreneurs fall into the trap of ignoring cash flow, or worse thinking of venture capital as cash flow. The business makes no money, and relies on venture capital to cover expenses. If it dries up the doors close, because there’s no cash coming in.
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Entrepreneurs ignore other; sometimes better, sources of financing such as bank loans, vendor credit, IPOs, hard-money loans, private equity, and crowd funding. These sources of financing are more expensive and often harder to get, but they can give the entrepreneur more control.
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Lack of cost control. Having a lot of venture capital gives a startup team incentive to control costs or keep low overhead low. Many unicorns end up burning through cash because they think the venture capital will not disappear. They might rent expensive office space; when the garage will suffice, or buy equipment they do not need.
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Failure to take advantage of existing financial resources. Venture capital stops many entrepreneurs from taking advantage of existing financial resources that could be more flexible. This could include money in investment or savings accounts, cash flow, existing lines of credit, vendor credit, mortgage equity or assets they could sell to raise cash.
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Failure to adapt or fix business plans and processes. An entrepreneur that gets venture capital; might have no incentive to ask why a product is not selling, or why costs are too high. Instead, he or she keeps right on going with a bad business plan until the venture capital stops rolling in.
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Wasting time and resources. Many entrepreneurs waste vast amounts of valuable time and resources on lousy business plans and terrible products, simply because they can get venture capital. Since somebody else is paying the bills, they have no incentive to pull the plug. Had they not received outside capital; these people might have avoided wasting valuable time, and moved onto something else.
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Sustaining a failed or money losing business. The final and greatest danger poised by venture capital is that it can keep a bad, money-losing business afloat. Instead of shutting down a failed enterprise, an entrepreneur that can get venture capital will keep it running and waste time and resources.
How to Avoid the Venture Capital Trap
There are some questions that can help an entrepreneur avoid the venture capital trap. These important questions include:
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Do we really need the money? If the business can survive without the venture capital, it would be a good idea to forgo it. The first goal of an entrepreneur should be to setup a self-sustaining enterprise, not raise funds.
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Do we have cash flow? If revenue is coming in, it is often a better idea to concentrate on growing cash flow and ignore venture capital.
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Does the venture capital fit in with our business plan or ultimate goal? It is very easy to get distracted from your business plan by large amounts of venture capital.
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What alternatives do we have? If there’s an alternative source of financing that gives you more control; it would be wiser to take advantage of that.
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How much money do we have now? If a business already has enough money to sustain its operations, it probably does not need venture capital.
The moral of the story is that you should always think long and hard about taking venture capital. Despite what some people think, it is possible for a startup to survive and thrive without it.
