Venture capitalists are motivated—at least in part—by the prospect of huge returns on investments that will make them and their investors rich.
The fact that VCs need to return large sums of capital to their investors creates some incentives that may not align with a founder’s goals. To meet their investors’ expectations, venture capitalists seek to invest in companies they believe can be the biggest, most successful companies in their market.
Some firms out there are happy with smaller returns and smaller exits, and some investors work closely with founders to make sure no decisions are made that the founders are not comfortable with. Other investors are motivated by, in addition to high returns and big exits, the impact their portfolio companies might have on the world. (You’ll learn how to research and discover firms aligned with your interests in Creating a Target List of Investors.) But the VC business model is predicated on growth—there are countless stories out there about companies that were pushed by their investors to move too fast toward becoming a $1B+ outlier. What’s the downside of that?
If you’re an entrepreneur, your goal is at least to build a successful business. Economic value, as measured by valuation or price per share, is not the only way to measure a business’s success. Neither are fast growth or ice sculptures at your IPO party. Think on and discuss with your team what success means to you. Does success mean fame, fortune, and everything that goes with it? Whether or not you decide to take on venture funding, you and your team or co-founder can get aligned on your goals by considering the following:
Impact. Many founders are motivated by a yearning to work in service of something larger than themselves. VC-backed founders who want to change the world still have to ask themselves: “But, will it scale?”
Lifestyle. The average time from founding to IPO is eleven years,* and there’s a pervasive culture of workaholism among startups that is reinforced by investors. Many founders self-impose a work week of 60+ hours. There is a widely held belief among investors, however unfounded or unproven by data, that long hours signal commitment.
Money. Entrepreneurship is hardly the best way to get rich. Given that most companies don’t succeed, think twice about starting a company before you quit your day job. That said, it’s OK to think about the numbers you’re comfortable with for now, and the numbers you want to get to. Would you be happy taking only equity and no salary for a couple of years? Do you have the means to do so? How about a steady salary of $75K a year? $1M after an exit? $100M? Make sure you understand the risks in taking venture funding that can affect the money you and your employees make even if the company makes it to exit, including dilution and liquidation rights.
Control. Many entrepreneurs start companies out of a desire for independence. But don’t forget: raising venture capital means selling a part of your company. Often, that means other people now have a say in how you go about doing things. “Being your own boss” doesn’t really fly when you’ve committed to do your best to return your investors’ money plus a healthy return. Raising money from venture capitalists can mean giving up control of your company. Raising a priced round usually means agreeing to protective provisions for preferred stockholders or giving up a board seat, which can allow investors the ability to legally block certain activities (like selling your company, raising further capital, and more).
Ownership. Many venture capital firms seek to own 5–20% of your company or more.* In most cases, a company will raise several rounds of financing, which will further dilute the founders’ ownership. It is not uncommon for a company to raise large sums of money and then sell. Because of liquidation preference, the founders might not make much at all, if anything, in that event.
Optionality. Investor money comes with expectations. Optionality, or having the option to sell your company but not the obligation to do so, means having control over your company’s fate. If you’re not sure whether you might want to sell your company in a few years, taking venture capital may not be a good idea. Given VCs’ incentives, modest positive outcomes (1–2X returns on the amount of capital raised) are not “venture scale” hence not interesting to most venture investors. In many cases they may be able to block a sale of the business that would be very lucrative to founders but doesn’t generate the outlier returns they seek.