The Dangers of VC Funding

“Don't Get VC Funding – It Will Ruin Your Company” - sounds like a familiar headline?

Securing venture capital funding seems like every founder’s dream. You get the financial resources to scale quickly, develop new products, and confidently enter new markets. However, VC funding comes with risks.

Before jumping into a VC partnership, make sure you know what to expect and can act in your best interest. This issue of Startup Founder Focus will help you explore the key risks associated with accepting venture capital in this high-stakes game.

Four main risks of VC capital

1. VCs biting at your equity and control

Equity dilution is one of the most immediate risks your startup can face when securing VC funding.?

VCs ready to flow funds into your company typically want an ownership stake—often, quite a significant one. With the percentage of your founders' shares dropping, your control over critical decisions potentially reduces, too. So, while bringing in investors to get the essential capital and strategic guidance, make sure you keep enough control to steer the company according to your vision. Over-dilution can trap you in a situation where you no longer have the majority say in critical decisions, which can lead your company off the course you originally planned.

2. Much pressure and overextension?

Venture capitalists invest to get returns, not for the greater good. Founders like you can face much more pressure to grow and profit if your business runs on VC money. This may push your company to premature scaling—much like broiler chickens hyper-fed into barely being able to stand on their feet (or suffering from operational inefficiencies or even failing, in a startup's case).?

Expanding too quickly without a solid market foundation can lead your business to overextension and resource depletion. This “grow at all costs” mentality can also detract you from focusing on long-term sustainability and ethical considerations.

3. Your startup underperforming

Another significant risk is your startup potentially failing to pay off the investment. You may have heard it dubbed as the “risk of underperformance.”?

VCs typically invest in businesses they believe have a high growth potential. However, not all startups will achieve their ambitious goals (at least, as fast as VCs want.) Underperformance can lead to strained relationships with investors, additional rounds of financing under less favorable terms, or even the need to pivot the business model entirely. If you have limited experience in managing investor relations, this is something you don’t want.

4. Exit pressures

Venture capitalists usually invest with the goal of eventually exiting the investment. There are three exits: through an acquisition, merger, or IPO. So, at some point, you might feel additional pressure on your startup to achieve a successful exit, which is no easy task.

5. Illiquidity trap

Illiquidity means your company may not be able to find a suitable buyer or achieve the desired valuation, as in a “successful exit.” For VCs, it means the inability to liquidate their stakes as planned, translating into prolonged periods of financial uncertainty and stress for your startup.

You’re not the only one facing risks.

And don’t mean your co-founders. While much focus is often placed on startup risks, VCs have theirs, too. Understanding these risks is crucial to have a more efficient and mutually satisfying partnership with this type of investor.

The truth is that investing in early-stage companies is inherently risky; the majority of startups do not succeed, and VCs must absorb these losses. This "high-risk, high-reward" nature means that VCs invest in multiple startups, expecting only a few to yield significant returns. The risk of underperformance and illiquidity affects them as much as it can affect your startup. Moreover, they invest considerable time and resources in supporting their portfolio companies, from strategic guidance to networking. If the startup fails to take off, these efforts can go unrewarded.

To take or not to take

Let’s be honest: avoiding all the risks is impossible. But reducing them is feasible. For instance, if you’re adamant about keeping the company’s stake within the co-founder circle, you might want to consider debt financing, grant funding, venture debt, crowdfunding, and revenue-based financing instead of VC funds. Also, you might want to have several funding options to balance off the risks.?

As a founder, it's crucial to weigh the factors carefully, ensuring the partnership aligns with your long-term vision and goals. By understanding and preparing for these risks, you can make more informed decisions and set your startup on a path to success.

If you’ve joined the founders' ranks, our Fintech expertise, VC connections, and development resources can help you kick off and grow. For startups, INSART is a meeting place of ideas, their realization, and investment. With us, founders like you get an effective strategic business plan, software development blueprints, investor pitch deck, executive summary, participation in our Fintech Startups Demo Days, and more.

.