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Why venture capital funding isn’t the right fit for every startup

Posted by Kanika Sinha

January 24, 2022    |     4-minute read (703 words)

There has never been more venture capital funding available to entrepreneurs. Global venture capital funding is on a tear, with startups raising a record-breaking $643 billion in 2021. Even billion-dollar unicorns are no longer rare. Thanks to this outpouring of funding, nearly 1,000 private companies are now part of the unicorn club, according to Crunchbase.

This begs a question for startup founders. With venture funding so widely available, shouldn’t you too be thinking about raising a round?

Not necessarily, according to David Kolodny, co-founder of San Francisco-based Wilbur Labs. Even though funding announcements garner admiration and awe, founders should stop fixating on VC funding, meaning they should look at raising money as an obligation to investors rather than an accomplishment unto itself, and should shed the mistaken belief that only raising more funding can lead to growth and success. Instead, they should think about whether they really need the funding in the first place, Kolodny said. 

Dig deeper

Venture capital funding has long been considered the centerpiece of entrepreneurhood. It is seen as the de facto path for founders, many of whom develop their business strategies accordingly. But for some companies, venture capital funding is not the best approach. 

VC funding brings obligation, shrinks flexibility

VC firms raise money from limited partners who bank on a sizable return on their investment over a specific time period. That means founders who accept VC funding inevitably need to scale up quickly in size and valuation, as well as lose autonomy in decision-making.

VC funding brings loss of equity stake

When raising venture capital early on, founders start giving away a portion of the company — often a substantial amount — in exchange for capital. They end up diluting their ownership, since VCs receive equity shares in return for pumping money into a startup. This dilution grows over time, as additional rounds of capital are raised.

VC funding isn’t for every startup

VC funding isn’t inherently bad; sometimes it is crucial due to the nature of business. For example, you will need significant funding to build your startup if you have a lot of R&D spending. 

But many startups that raise venture capital likely didn’t need to. And even when they do raise a round of capital, many still fail because building a company entails so much more than funding. Rather than obsess over raising capital, founders may be better served by strategically planning and bringing in customers before evaluating all funding options.

If VC funding appears to be your only viable option, Kolodny advises working in reverse from your goals. Instead of contemplating what you’d do if you had $5 million in funding, think about what it would look like if your company grew faster, how much money you’d need and what would be the ideal source.

Ok, so what are the alternatives?

Before opting for the VC funding route, Kolodny suggests founders consider these alternatives:

Prioritize revenue

While funding might solve your problems today, it’s apt to create new problems tomorrow. Rather than joining the frantic race to raise capital, founders should focus on business planning, prioritize revenue and implement strategies to get customers to vote with their wallets. As former Google chairman and CEO Eric Schmidt has said, “Revenue solves all known problems.”  

Consider all available options

Remember that raising money is not a one-size-fits-all endeavor. If you do need funding, don’t automatically assume this means VC money, and consider the many alternatives, such as crowdfunding, angel investors and grants. Though these options aren’t as splashy as VC fundraising, they are often more founder-friendly.

Remember that VCs don’t have monopoly on networks

You do not need to opt for venture funding to cultivate relationships with potential employees, partners and customers. For instance, strategic advisers can provide equally valuable guidance and connections to help your startup grow without taking away your independence or ownership.

Key takeaway

VC funding typically comes with strings attached. It can also create more noise than it’s worth in terms of demands on your energy and time. Instead of automatically pandering to investors, focus on building the business first under the assumption that growth and investments will follow.

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