The venture capital funding firehose that has sprayed money at technology startups over the last few years is drying up. To cite just one example, on May 12, behemoth VC investor SoftBank announced that it was cutting its planned startup investments 50-75% through next March. They are by no means alone in tightening their belt.
Accordingly, startups can no longer rely on the free flow of capital to fund operations and fuel growth. And for many startups, that’s a good thing.
In my experience providing legal counsel to technology startups and entrepreneurs, I’ve seen a marked rise in companies becoming overly reliant on fresh capital to survive. During this easy-money cycle, it’s almost as if many companies decided that their business model was to continually raise more money. And VCs were happy to oblige.
The problem, of course, is that when there is so great a focus on fundraising, too little attention is spent on “old-fashioned” things like building a product people want, acquiring customers, and generating a profit.
These things are becoming an urgent priority now, but for many, it will be too little, too late.
For many companies who are quickly burning through cash, the smarter move would have been raising less venture capital, or none at all.
Here are some of the reasons why startups should exercise caution when determining whether to raise venture capital.
Raising Capital isn’t a Proxy for “Success”
It’s not surprising that many startup founders equate raising cash with achieving success. For one, it’s a form of validation (“we’ve made it!”) when an investor makes a big bet on a company. In addition, raising a large venture round makes for a juicy headline. As many companies are learning today, it’s a fleeting rush.
VCs Have Their Own Objectives
The venture capital business model is to make 100 bets and hope 5 to 10 of them pay out. And by “pay out” I mean a $100 million+ exit or IPO. That means they’re going to push the companies they invest in to grow like crazy—even if a slower march toward profitability would help ensure the long-term viability of the business. In a sense, every startup that a VC invests in is, from the VC’s point of view, a chip on the roulette table.
Startups that Raise Venture Capital Funding Fail to Learn Business Fundamentals
Because VCs push startups so hard for revenue and growth, company leaders often ignore timeless business fundamentals. They spend too much and focus too little on profitability—investing two dollars to make one.
Raising Venture Capital Funding Leads to Dilution
The math is simple: The more venture capital a company raises, the more equity the founder relinquishes to investors. The counterargument is that while raising capital may shrink the founder’s slice, it will be a slice of a larger pie, but it doesn’t always work out that way. Just ask all the companies out there who raised massive capital over the last couple of years, only to see their valuations get cut by 50% or more over the last six months.
You Can Succeed Without (or at Least, with Less) Venture Capital Funding
Sure, it would be great to be the next “unicorn.” But they’re called that for a reason. And for every unicorn, there are countless startups with lots of potential who flamed out in search of hyper-growth. We just don’t hear about the losers nearly as much, because “survivorship bias” leads us to focus on the winners.
The truth is that you can still build a great company without raising, or raising less, venture capital. There are plenty of companies, such as MailChimp, Basecamp, Shopify, and Canva, who didn’t rely on venture capital to grow. In some cases (e.g., Basecamp), they remain entirely bootstrapped. In others (e.g. Canva), they wait to raise capital until their business model is proven, which leads to much less dilution for the founder.
The big lesson here is not to avoid venture capital at all costs—it’s to avoid designing your business around the need to raise capital. Focus instead on:
- Building a product that addresses a customer’s need
- Generating not just revenue but also profit
- Developing skills a founder needs to lead and grow a team
With discipline and ingenuity, founders can start and grow virtually any business, including a tech-enabled one, without raising venture capital. And if a business does need an injection of cash? An old-fashioned loan may be an option—often a good one. A loan can serve as a forcing function to generate the cash flow needed to build a sustainable business.
There’s no single playbook for entrepreneurship. This means, despite what you may have been led to believe, that venture capital is not an essential ingredient for business success.