Why Entrepreneurs Should Not Raise Investor Funding
There is so much start-up chatter around financing rounds and valuations that you may think the purpose of starting a company is to raise money. If you’re like most entrepreneurs, you may even dream of the day when you’re able to raise funds from investors. There are many reasons for starting a company, and hopefully raising money isn’t at the top of your list.
There’s more to entrepreneurship than raising investor funding. Money is important to keep a business operational and growing, of course, but many companies don’t need to raise investor funding in order to be successful. In fact, raising investor funding could even be detrimental to an entrepreneur. If you find you’re debating whether to go down the path of securing funding, here are 10 reasons why you may be better offer avoiding taking outside investment.
1. You Could Lose Control of Your Creation
Think back to why you started your business. It was likely because you had an idea and knew that only you could execute it. You worked and continue to work countless hours to bring your vision to life. You’ve carefully assembled your team. You work for no one but yourself.
The best thing about having your own company is that you get to decide what work gets done, how much you work, what to do with your earnings, etc. However, as soon as you receive venture capital funding, this all changes. Venture capital (VC) investments come with significant oversight and input. The VCs usually take a board seat and require certain conditions to be met. VCs are most known for their almost unwavering focus on growth.
This is not to say that all VC funding is bad. Instead, you should carefully consider what you’ll be giving up when welcome funding. You may have to give up control over the strategic decisions. Due to the conditions that often accompany investments, you may find that the creativity that flowed freely in the pre-investor days disappears or is severely limited.
2. You Could End Up Wasting Significant Time and Energy
Preparing for pitch meetings is a time-consuming process. At a minimum, you’ll have to:
- Develop an “elevator pitch” or short 30-second explanation of what your company does that captures others’ attention
- Network with venture capital firms and other investors in order to set up pitch meetings
- Develop a pitch deck, which needs to include a clean, clear and persuasive explanation of the problem you’re trying to solve, how your product or service addresses this problem, important metrics, business model, competition and team
- Attend many meetings with no result
- Respond to investor questions during due diligence processes
- Negotiate term sheets and other investment details
Do you or your team have time and energy to do all of that? Do you have the resources and knowledge to accomplish all of those points? Are you prepared to hustle?
It may not be in your best interest to devote significant time to pitching as you’re figuring out your business model, building your brand visibility, and learning how to attract customers. As a new company, it will be an uphill battle to convince investors of your value proposition. You’ll likely have to have several meetings with multiple potential investors.
Also, if you do secure funding, the money likely won’t arrive for a few months. In the early days of business, it may be a better use of time to cement your vision.
3. Your Ownership Stake will be Diluted
In addition to losing complete control over important strategic decisions in your company, each funding round dilutes your ownership. As the founder, you started with 100 percent ownership. You may have given up some of that ownership by giving early team members stock or options. When you bring in outside investors, they give you money in exchange for ownership or equity in the company. This ownership can only come from the existing, original ownership, meaning your stake will go down.
All companies that accept outside funding face this scenario. As your company becomes more profitable, the monetary value of your ownership may be worth more even as your ownership share is diluted. However, it’s important to understand what dilution means for you, your team members and for the company overall as new investors or owners come on board.
4. You May Not Need Big Funds
It’s easy to get caught up in the hype of raising funds. Afterall, that’s what start-ups do! Founders get major bragging rights and are viewed as more successful depending on how big their funding rounds are, what valuation they achieve and who participates in them. However, before you seek funding, carefully evaluate your budget, projections and strategic goals. Here are some questions to consider:
- Are your revenue projections reasonable?
- Are there other revenue streams you aren’t including?
- Can you raise prices? Will that cover your shortfall?
- Review your expenses – are your assumptions reasonable?
- Have you included unnecessary expenses?
- Can you make any adjustments to your expenses?
- Have you forgotten anything?
After going through these questions, carefully consider if you still need the additional investment. If you do need additional financing, determine how much do you need. Outside investors typically invest significant amounts of money. Consider other forms of financing such as family and friends or a line of credit if your capital demands are not as extensive as you originally projected.
5. You’ll Spend Everything You Raise, Meaning the More You Raise the More You’ll Spend
You know how you promised yourself that when you moved into the new place you wouldn’t fill it with clutter, but somehow nearly every inch of available space is filled (or maybe you live in New York or San Francisco where small, cluttered apartments are nearly unavoidable)? Well, raising funds is kind of like that. Even if you think you won’t need to use all of the outside investment, you will. Many companies find that typically, within 12 to 24 months, they’ve fully spent their investment.
If you raise a substantial sum of money, then you’ll face pressure to use it as you promised in all those pitch meetings. Get more space, hire more people, boost your software development, ramp up your branding and more – there’s a tremendous risk of over-building.
You’ll also miss out on the creativity that the lean years can inspire. Now that you have money to throw at a problem, it’s tempting for that to become the default and easy way out. Sometimes, just because you can say yes to a new feature or product, it’s not always a great idea.
6. Your Market Size May Not Warrant Investor Funding
While you may aspire to the success of companies like Facebook or Uber, take a moment to evaluate your expectations. You can still dream big, but it’s better to dream big within the market segment in which you compete. Before seeking funding, carefully determine how big your market potential is, and be realistic.
Professional investors want to earn outsized returns on their investments in early-stage companies. In order to do that, the market opportunity has to be there. Even if your product or service is promising, investors may not be interested if the number of potential customers does not meet their investment criteria.
If you’re aiming to be the best fish in a small pond, then you may want to focus your efforts on bootstrapping. If you do want to be the next tech unicorn, good luck.
7. You’ll Face a Higher Bar the Next Time You Want to Raise Funds
Beware the down round, it’s brought many a company, well, down.
In order for investors to part with their funds, they need to believe that they’ll be able to make at least 10x or more on their invested capital. Depending on your stage of growth and industry, some investors may demand even higher multiples than that.
Let’s say you raised $5 million on a $20 million valuation and find you need to raise more money. It is going to be massively more difficult to raise an “up round” of $8 to $10 million at a $40 to $50 million valuation than your first round. If you can’t achieve a higher valuation than your previous round, this is what is known as a dreaded “down round.” It’s harder to convince investors to turn over their money in return for a lower valuation. It is possible, just not preferable. (And you’ll probably gain a reputation as a “problem child company.”)
Don’t try to raise as much money as possible, but also don’t raise too little. Raise what you think you’ll reasonably need. No matter how much you receive, know that this sets the bar for future financing rounds.
8. You May End Up Setting Bad Precedents
Although you don’t mean to do your company harm in the process of raising investor funds, that’s exactly what can happen. Pitching to investors is often the first time people outside of your company are introduced to your business model. Whatever assumptions you present may eventually come to define your company. Barring a “pivot”, or a complete change in your strategy, it may be hard to change the consensus views on your business.
Further, any funding you accept will come with terms. When you are a new company, you may not have much negotiating power. This means that the investors will be able to control the discussions around terms. Due to this imbalance, you may end up giving away the wrong terms. These terms could limit or affect certain strategic decisions down the road.
9. You May Have to Contend with Investors who Overpromise and Underdeliver
Many VCs out there have wonderful experience to share and helpful advice to give. At the end of the day, all the advice in the world means nothing if it’s not paired with successful execution. And who is doing the execution? That’s right, you and your team are.
Venture capital firms provide a very valuable service. They provide cash. They share knowledge. They can help validate products, ideas, teams and markets. They boost your credibility and visibility. They can connect you to important resources.
However, this doesn’t mean that you can’t achieve success without a VC – as many VCs may want you to believe. You and your employees, who are on the ground day after day, moving the company forward, are what is going to make you successful.
10. You May Become Addicted to Raising Money
Not addicted in the 12-step meeting sense, but rather addicted in the sense that you may forget how else to grow (raise prices, cut costs, become more productive or efficient, etc.). It can be easy to fall into a trap of raising money, spending this money and then needing to go back into the market for additional capital when your sales projections fail to pan out.
This cycle can mask serious strategic flaws, for a time, anyway. At some point, investors will realize that you aren’t meeting your goals or projections and the capital will dry up. If/when this happens, the future of your company, which you worked so hard to build, will be in serious jeopardy.
Investor Funding is Not for All Entrepreneurs
Yes, there are many companies that have benefited from investor funding. It’s not all bad. However, there’s more to receiving this form of capital than the hype around closing successful rounds may suggest.
The process of obtaining funds is time and energy consuming and will result in you losing some control over the company you built. Deciding how much money to raise and at what valuation are tricky. A misstep – too little or too much – could have serious ramifications for the future of your company.
Lastly, by raising funds, you’ll lose some of that scrappy, lean, entrepreneurial spirit that made your venture so exciting in the first place.
Before seeking investment, remember why you got into business for yourself. If possible, hold out (either a little longer or forever) before engaging with outside investors. You may find your company is perfectly successful without them.Resources: https://venturebeat.com/2013/07/05/dont-raise-money/ https://hackernoon.com/do-not-raise-vc-funding-3-reasons-against-it-7c5f6d4efbec https://www.groovehq.com/blog/you-probably-dont-need-funding https://bothsidesofthetable.com/why-raising-too-much-money-can-harm-your-startup-5adc112e1259 https://www.inc.com/dave-bailey/why-raising-money-early-is-a-terrible-idea-and-what-to-do-instead.html