Raising venture capital has become a standard part of the business startup model, but you should tread carefully if you’re considering wading into the world of so-called “business angels.” Hard data supports an undeniable trend: there tends to be a surprising inverse relationship between the amount of venture capital a new business raises and its long-term prospects for success. The less private investment a startup generates, the more success it tends to have.
Why? Analysts point to five key reasons.
Trying to Attract Venture Capital Drains Resources
As anyone who has launched a new business will tell you, starting a new company is a full-time task in and of itself. The same is true of finding venture capital sources, and the more time a new business owner spends searching for financing, the less time he or she has to invest in what really matters: getting the company off the ground.
Experts recommend a different approach. Instead of sinking untold hours into finding venture capital, spend that time building a successful business. Investors are more likely to put their money into a company that’s already working, and you’ll expose both yourself and your financiers to less risk if your business is on solid footing.
Venture Capital Investment Can Diminish Your Stake in the Company
Business financiers and venture capitalists recognize that they operate in a high-risk, high-reward sphere of investment. As with all forms of speculation, minimizing risk is a key part of finding a good opportunity. Thus, the vast majority of venture capitalists will seek to reduce their risk exposure by imposing restrictive and even taxing terms in their shareholders’ agreements. This can greatly diminish your own stake in the company and reduce your own motivation to succeed.
Your Stake Can Shrink Over Time
Even if you manage to secure relatively favorable initial terms, business owners tend to keep a relatively small stake of their businesses after the first round of investment. If and when additional rounds of financing are secured, your own stake will continue to get smaller and smaller and smaller every time. While this can still lead to a handsome bank account if your business turns out to be wildly successful, those situations are few and far between.
Again, it’s better to build up the company so you have a stronger presence of what is known as “customer traction.” Customer traction gives you leverage when dealing with investors; your business is already a known quantity, and it’s already generating reliable revenue streams that are likely trending in the right direction. This can help you negotiate more favorable terms if you do turn to the private venture capital market to try to take your business to the next level.
Venture Capitalists Don’t Always Know Best
According to a recent study conducted through Harvard Business School, more than 50 percent of venture capital investments earned only single-digit returns, while only 20 percent of investments generated returns in excess of 20 percent. Generally, business owners believe that venture capital investments will get them into the 20-plus ROI range, but as the study shows, that simply isn’t the case.
Worse, about 20 percent of all venture capital investments resulted in negative returns, which means that you’re just as likely to end up losing money as you are to generate a worthwhile outcome. While many venture investors only pledge their money in return for a strong say in the future direction of the company, these numbers should make you think twice about whether or not their advice is worth following.
History Isn’t On Your Side
Highly successful venture capital funds generate only one or two so-called “winners” for every 10 investments they make. That means you’re looking at an 80 to 90 percent failure rate right from the get-go. In the world of venture capitalism, those rare success stories are used to cover losses from the much higher rate of losing investments.
Given that the odds are so stacked against you, it may just be better for you to seek less risky, more modest sources of financing. Venture capital shouldn’t be used a substitute for the good old-fashioned hard work you need to do if you really want to succeed in the business world.