Jun 21 2005

Thinking of taking venture capital? Don’t!

Here’s a thought for those of you considering taking venture capital – don’t do it. Seriously. It’s not worth it. Ok – so I’m not 100% serious. I’m trying to make a living investing in companies and would therefore be out of business if everyone followed this advice, however I think that for the majority (50%? . . . 80%?) of entrepreneurs taking venture capital money is a mistake. As I explain why this is the case, please read from the perspective of someone who is actually trying to encourage people to go into the process with their eyes open more so than I’m truly trying to scare people off from raising venture money. The worst thing you can do when you take venture capital is to go into the relationship with a misunderstanding of what each party expects – an example of that in a minute.

While I obviously believe that venture capitalists add real value to the businesses they invest in (perhaps the subject of another post), there are two things that come along almost by definition with venture capital that not every entrepreneur probably really wants: 1) VCs have opinions and they are not want to share them. This should be obvious, but rare is the early stage VC that gives a company money, asks for quarterly updates and then pretty much lets them alone. For starters, we have a fiduciary obligation to our investors (known as limited partners or LPs in VC parlance) to be good stewards of their money and part of this obligation is to keep regular tabs on the companies in which we’ve invested. Mostly though, VCs believe that they have something to add to the mix. We see lots of different business situations, experience similar challenges across businesses and believe we can offer the benefit of both our own operating experience (since most VCs have some type of operating background) as well as the experiences of the rest of our portfolio. 2) The goal of a venture investment is to make money – i.e., sell the business or go public. This as well should be a pretty obvious thing, but I’m not entirely sure that it’s always understood. In the VC business we take a box of money fro our LPs and attempt to give them back that box with more money in it. This requires us to ultimately get out of every investment – either through a sale of the business or an IPO (there are rare cases where companies redeem investors’ shares at a specified premium, but this almost never happens). Since most venture funds have a 10 year life this means that there will be pressure on you and your business to grow quickly and sell (or go public) within this period (which shrinks if your investment is made in subsequent years of the fund).

Rather than belabor the point (or come up with the 10 item list rather than a 2 item one) I’ll tell a quick story of a very good friend of mine who should not have taken venture capital. He did, of course, and after the bubble burst and with his business in a poor investment sector (telecom IT) his investors (both very large and well respected VC firms) were ready to call it quits. He retrenched and came up with a new plan that leveraged the existing infrastructure and tried to convince his investors to stick it out. Ultimately they decided to pull their money (about ½ of their investment was remaining). My friend went around for a bit trying to drum up capital for his business. I remember talking with him during this time and trying to convince him not to take any more venture capital. He had a great team assembled, had equipment from the business that he was allowed to keep when his original venture firms pulled out, and had a vision for how he wanted to run his business that frankly was not necessarily compatible with taking venture money (really because of #2 above rather than #1). He wanted to run a business for a while, grow, but at a measured pace and experiment with some ideas he had on how to build a solid culture and a lasting business. Ultimately he came to the same conclusion and together with some of the other management team came up with enough money to finance the business. Fast forward 3 or 4 years now and he has built a solid business. He’s cash flow positive, growing at a reasonable pace and he has created the type of company that he always wanted to work in. He’s clearly benefited from having to figure this out on his own and while he has a board, he answers to himself (and a few friends) as investors. He was telling me a few weeks ago that he really wants to keep running this business for a while – he wouldn’t sell it now even if he could.

So think before you take the venture capital leap – and do so with your eyes wide open.

Comments and thoughts are, as always, welcome.