Let’s begin by dissecting the title “Venture Capitalist”… Here’s a description from our good friend, Wikipedia:
Venture capital is a type of private equity capital typically provided by professional, outside investors to new, growth businesses. Venture capital investments are generally made as cash in exchange for shares in the invested company. A venture capitalist (VC) is a person who makes such investments.
Here are a few things every start-up should consider before seeking a VC that will let you sulk in his moolah:
The average founder of a startup who uses a VC owns 60% of his property initially, and 10% upon exit. That’s a significant amount of ‘company’ that you’re giving away, think about it. Now let’s take a look at what the other 40% of your company will be focused on. Money. Yes, that’s right, let’s stir up some controversy here. Think about what makes the average VC happy. Why would someone take risk in investing into your product? Money. It may turn out that the concern for money comes before your company, or your customers. VC’s can have the power to hire and fire people, when they own such stake in your biz (including you!).
If its not the ultimate necessity, do you really want this cash-cow second in command of your company? (Sometimes the answer is yes, but situation this comes into play later).
Do you really need it?
Hell, there’s no point in finding a Venture Capitalist if you don’t need one. The average initial investment is $3M+, and if you honestly think that you need 3 million in the bank for your startup to succeed, you’re either launching the next Paypal, or you need a reality check. Now of course, you’ll have many people bumming off of their VC cheques to pay for their apartments, their groceries, et cetera – if this is what you want to achieve raising funds for your company, why not just take out a loan?
If your reason for hiring a VC is to lower your personal risk, that means you don’t have enough faith in your startup to begin with. Entrepreneurship is all about risk taking. In fact, the actual word “entrepreneur” can be defined as “a person who organizes and manages any enterprise, especially a business, usually with considerable initiative and risk.”
Startup costs have gone way down over the past few years. The average funding needed for a startup is now 1/10th of what it was 2 years ago. Entrepreneurs can now outsource development work, which serves as a major benefit when cutting costs. Take a look at some popular success stories that have been circulating the blogosphere recently, start-ups have been launching for mere $X,XXX – low $XX,XXX! Save up, and if you must, raise some angel funding to cover promotion.
Abiding by conditions:
You couldn’t have thought VC’s would just give you money without conditions, right? Here’s a list of some of the conditions that you should expect, courtesy of Business Week:
- Anti-dilution protection. If the company’s stock price goes down any time in the future, they get additional stock for free.
- Dividends. In addition to stock, they get a guaranteed rate of return.
- Liquidation preferences. VCs get their principal and dividends back before anyone else gets a penny.
- Participating preferred. They get to double dip—they first get their investment plus dividends, then the value of their stock.
- Mandatory redemption. This requires the company to buy their stock back by a certain date, establishing a deadline for an exit event.
- Demand registration rights. The VCs can force the company to file a registration statement with the Securities and Exchange Commission to initiate an initial public offering—another way of forcing an exit event.
- Approval rights. The VCs must approve any new financing and have the right to participate.
- Reps and warranties. You’ll also have to accept personal liability for representations you’ve made about key aspects of the company. They will have the right to sue you for all you own if you forgot to give them any bad news.
- Friends and family are often more than willing to invest in your startups. They know you, and what you’re capable of.
- Don’t use expensive software! Stick with freebee’s such as Basecamp (and the rest of the 37signals apps), Skype, Google Spreadsheets, and Blinksale. If you must upgrade, the monthly fees are very affordable.
- There are many budgeted designers and programmers that are just waiting to be found! Browse through logopond for some logo designers, and post some job listings on one of the many job boards. *Hint hint: Take a look at our first sponsor, who happens to be a genuine designer with shockingly low rates.
- Who needs an office? Not me! A lot of people who acquire VC funding spend it to relocate or buy office space. Working from home is perfectly fine, and saves a fair bit of costs.
- Still short? Mortgage your house, and save save save! Another option would be is to bring some developers onto the projects as partners.
Before going to any Venture Capitalist, make sure you thoroughly weigh out all the positives, negatives, and alternative options.