Venture capital is one of the most common sources of financing that founders seek if they have an early-stage startup or high-growth company, but it isn’t right for everyone.
For every startup founder’s success story with VC, there are several more stories of founders who have succumbed to the unintended consequences associated with their financial implications. This is not a negative against using VC as a financing source; however, VC needs to be leveraged in the right way for high-growth companies that require lots of capital.
Contrary to popular belief, venture capital does not even represent the majority of startup financing. According to Fundera, only 0.05% of startups receive funding from venture capital. There are various forms of funding a founder can pursue, and equally important to consider is the timing of when a founder receives funding.
Regardless, startup founders should consider what their exit plans are long before jumping into an agreement with a venture capital firm or another financial investor. If you are a founder, it is important to recognize that your business is a significant source of personal wealth, and having the right capital strategy will allow you to make an informed decision when financing.
Table of Contents
- View examples of outcomes when selling your business
- Giving equity means you will lose a degree of control and autonomy over business-related decisions
- Majority ownership may be more lucrative than having higher company valuation with a lower percentage of ownership
- There are financing options that don’t involve ceding ownership equity or signing away control rights
- Get an M&A advisor in the early phases of your startup journey
Every Founder Needs to Know What Outcomes They Want
Before you have a capital strategy, it’s essential to think about outcomes – no matter how far away they seem right now. An outcome should encompass your desired goals for your financial, lifestyle, and professional state in the future as well as the ideal timing of your exit.
If you are not sure what type of outcome you want from your business, here are a few examples:
- Sell your business so you can spend time with family, travel, or pursue a hobby
- Lead a business long term, only to sell to a larger firm once you are ready to retire
- Liquidate the value of a family business if the next generation does not want to run it
- Sell to a strategic buyer who accelerates the vision of your business and preserves your legacy
- Scale a business quickly and sell early to gain enough capital resources to start another business and take some money off the table
- Grow a business so it is attractive for a larger firm to acquire and stay involved post sale, or grow a business to be a billion-plus company that can IPO
While the above examples represent some of the outcomes that an owner could have, all the examples have very different financial strategies – which is what informs your approach to capital.
Potential Drawbacks of Financing Through VC & Other Financial Investors
VC and other financial investment firms often have a “grow at all costs” mentality which can be stressful and financially risky. Many startup founders backed by a venture capital firm quit their jobs and work for months or years before receiving any profit, which can lead to reliance on personal loans and accruing credit card debt in the meantime.
According to Investopedia, venture capital firms will dilute a founder’s ownership by taking anywhere between 25 and 50% of a new company’s ownership. This also does not account for startups that have subsequent rounds of funding, which can leave a founder with 10% or less ownership. Having your ownership greatly diminished means you will have far less to gain once you ultimately sell your business – even if it sold for maximum value.
For example, having more ownership is often more lucrative than having higher company valuation with a lower percentage of ownership. After all, if you sold a company for $150 million but only owned 10%, you would still make less money than selling a company for $50 million while owning 80%.
Investors can also remove the decision-making control of a founder. Such founders will likely have misaligned investment timeline interests with VC, which can impact their personal capital strategy.
To illustrate, if a founder of a VC-backed startup had grown their business to be valuable enough to exit and make a profit that could boost their personal wealth, such as by purchasing a home or making noteworthy investments, the founder would not have the authority to sell. Instead, that founder would likely need to wait until the venture capital firm has made their return on investment based on when they began financing, which may happen at a far later date or when it is a less ideal time in the market to sell.
Venture capital can be extremely useful when you have a capital-intensive business to build and if it is growing extremely quickly. It is important to keep in mind that while not every startup can afford to grow without financing, they also don’t need endless resources to succeed.
According to Bill Gross, renowned investor and thought leader, timing is one of the top factors that determine a successful startup. He suggests that startups should allocate the resources they need to prove their business and manage their burn rate wisely to give them maximum optionality. By applying that mindset, you can manage your capital strategy and strike when the best opportunities emerge – including selling your business.
Additionally, there are various ways of financing that don’t involve ceding ownership equity or signing away control rights. These methods include crowdfunding platforms, alternative investors, lines of credit, revenue-based financing, and grants from local governments or organizations that offer startup funds for promising projects.
Seek the Experts Who Will Set You Up for Success
Developing the right capital strategy around your goals is paramount because the type of financing you pursue also impacts your personal wealth.
STS Managing Director Shamil Hargovan said that founders who are deliberate with their corporate strategy understand that carefully timing their exit will deliver the best financial results.
“The day you take on financing and your ownership stake shifts, it becomes harder to control the timeline of your sale… and that can impact you more than you think,” said Hargovan. “If you’re proactively preparing for M&A in the early phases of your startup journey, you’ll be ready to seize the perfect opportunity when it comes your way and drive the sell-side process in a timely manner.”
As a team with many former entrepreneurs, our expert guides at STS have helped several owners navigate their exit strategies. By ultimately setting them up to walk away with maximum value when they eventually sell, they can create more opportunities for their next chapter in life.
If you are a founder who is interested in finding more resources about M&A and preparing for a business exit, please visit our Insights & Press page to view our other thought leadership articles.