Despite a pullback in investment in 2016, Venture Capital (VC) is big business. According to KPMG, VC investments have grown from $31 billion in 2010 to $69 billion last year. While this is a slight pull back from 2015, a lot of money is flowing from VC funds to companies around the country. However, not every VC investment works out. In fact, many of these bets fail and when this happens, it is the owner who is most vulnerable. Don’t let this happen to you, learn about what owners should know about VC investment before it is too late.
- Most VC Funding Does Not Work Out
Unlike Private Equity (PE), which focuses on businesses with an established presence, VC focuses on younger companies. These companies are often newly formed, have a technology component, and have little more than a toehold in the markets they serve.
As such, the odds of a VC investment working out and you becoming the next Mark Zuckerberg is extremely small. This is played out in the stats. In 2012, VC invested in close to 3,700 companies. In the same period, there were only 49 IPOs and 449 companies were acquired. In simple terms, VC-backed companies have a one-in-six chance of a successful exit.
The rest of these companies either muddle along or get boarded up.
When this happens, it is the owner who are often left out in the cold. Normally the VC will structure the deals in such a way that they not only control the board, but they also have a say in any bankruptcy proceedings.
While trying to fight the funds can be expensive and often times, the owners fall into the trap of believing myths about litigation finance, such as it is not for those who are pursuing legitimate claims.
The result is that the owners often end up on the outside looking in at their companies and in some cases, they may even be personally liable to repay the VC fund. This can push the owners into personal bankruptcy.
- VC Money is not Free
VC investment is not a bank loan and there is no monthly payment and interest. However, VCs are not charities. They are looking to invest in high-growth opportunities. This search for growth is one reason why VC funds invest in high-risk early-stage companies as they want to be on the rocket before it takes off.
Don’t let the euphoria of bagging a VC investor allow you to take your eye off the ball. The clock is ticking from day one and these investors expect returns of 30%, 50%, or even 100% per year. And you don’t have 3-years to pay them back either – those days are long gone. Today, a VC wants their investment to begin paying off in the first year. If not, then they will start using their seats on the board to make changes to your company.
- There is Such a Thing as Too Much
Some sources will say that you can never take on too much VC money – this is not true. A massive investment round can set you up for failure. First, it will overvalue your company, making it harder to deliver a return on investment. Second, this sets you up for a ‘down round’ which is the kiss of death for most companies.
Third, it might sound counterintuitive, but having too much cash on hand may influence bad decisions. This happens when you start spending cash like there is no tomorrow, often on expenses that have little chance to help grow your business. As such, working on a tight budget forces you to prioritize and to innovate what activities you invest in.
- Firing a VC is Almost Impossible
These firms are professional investors and it is very rare for them to make a mistake which may allow a portfolio company to easily terminate their agreement. As such, owners need to conduct due diligence on their VC investors. It’s not just enough to accept a VC’s cash, you need to know how they will help you grow and how will you be able to work with them.
Talk to former employees, former portfolio companies, and even current portfolio companies before you take a VC’s cash. Once you accept an investment it is like taking an oath of omertà.
Remember it’s easier to get a divorce than to terminate a VC investment, do your homework and look before your leap.