Before pursuing venture capital (VC) funding for your business, you should consider the various pros and cons and how they may be applicable to your company. We’ve compiled a list of venture capital advantages and disadvantages for your consideration.
| Venture Capital Advantages | Venture Capital Disadvantages |
|---|---|
| Offers access to larger amounts of capital | Reduces ownership stake for founders |
| Has no monthly payment requirements | Diverts attention from running the business |
| Doesn’t require collateral to secure financing | Has funding opportunities that can be competitive |
| Provides expert business management assistance | Can be relatively expensive |
| Comes with networking opportunities | Requires setting up a board of directors |
| Offers assistance with hiring and building a team | Creates high expectations for business growth |
| Raises the likelihood of increased publicity and exposure | Comes with the risk of business failure if goals aren’t met |
| Assists with raising future rounds of funding | Reduces leverage in negotiations |
What is venture capital?
Venture capital is a way to raise money for your business. Funds typically come from VC investors that will require equity ownership in your company. The flip side, however, is that there are no loan repayments to be made. VC investors almost always have some form of industry expertise, and because of the ownership stake they’ll have in the business, they will have a monetary incentive to see your firm succeed. VC investors often target high-potential, high-growth companies.
Our guide on venture capital elaborates more on the details of how venture capital works for funding startups, as well as the steps you need to take in order to get this type of funding.
Advantages of venture capital
Obtaining venture capital has a number of advantages. It can be a good option for startups that have high-potential businesses that may have trouble getting a small business loan or for those looking to obtain capital without taking on debt. Besides money, venture capital firms can provide business advice, introductions to potential future investment partners, and help secure future rounds of funding.
1. Offers access to larger amounts of capital
Startups needing access to capital will likely be ineligible for large amounts via a traditional business loan. Additionally, it’s likely that a lender has various eligibility criteria that may be difficult for new businesses with limited resources to meet.
Meanwhile, venture capital firms can provide funding amounts as small as $100,000 for startups in the seed stage and as high as $25 million for more mature startups. You can also potentially raise venture capital multiple times, which gives you access to more capital than loans would allow you to obtain.
2. Has no monthly payment requirements
Rather than taking on debt like with a business loan, you can provide equity in exchange for funding. In other words, if a venture capital firm invests in your company, you won’t need to make monthly payments like you would with a traditional startup business loan. This frees up working capital, allowing you to reinvest by improving products, hiring a larger team, or further expanding operations.
3. Doesn’t require collateral to secure financing
It’s common that business loans require some form of collateral to mitigate risk to the lender, whether it be secured via business or personal assets. With venture capital, you don’t typically need to offer collateral to secure financing.
4. Provides expert business management assistance
Typically, venture capitalists are experienced business professionals who can offer guidance with regard to the operations and growth of your business. Whether it be monitoring financial performance, solving day-to-day issues, or helping scale a company, their guidance can help you navigate risks and get your company on the right path to growth and success.
5. Comes with networking opportunities
Often, you will work with partners from the venture capital firm, the other startup founders who have received funding from them, and the experts from the networks of both venture capital firms and the startup founders. With these connections, you can forge new partnerships, build out your client base, hire key employees, and raise future rounds of funding.
6. Offers assistance with hiring and building a team
The team you need to start a company and the team you need to scale are often not the same — and venture capital firms can help get key people in place at the company to help you grow. Also, many potential employees may consider a venture-backed startup less risky than a traditional startup with no funding, making it easier to recruit a talented and well-rounded team.
7. Raises the likelihood of increased publicity and exposure
Working with a venture capital firm can add credibility to a startup, especially for founders who haven’t built other successful companies. The increased publicity can lead to getting noticed by potential employees, customers, partners, and other venture capital firms interested in raising funding.
8. Assists with raising future rounds of funding
To better the odds of a venture capital firm’s return on investment, it will often assist with raising additional funding for your business. You may be introduced to other firms that can further invest in your business venture, especially in the later stages of scaling your company. Keep in mind, venture capital firms often reserve the right to invest in future rounds of funding and often contribute additional capital as your business grows.
Disadvantages of venture capital
While raising venture capital can be a worthwhile financing opportunity, there are some potential drawbacks to be aware of. Before pursuing this financing option, you should ensure that it’s worth giving up some level of control within your company. Besides having to maintain growth, you will need to pass a due diligence process and have someone from the venture capital firm sit on your board of directors to oversee your actions.
1. Reduces ownership stake for founders
One of the biggest downsides to raising venture capital is having to give up equity in your business in exchange for funding. For business owners who are unwilling to give up a portion of their company, this route of financing may not be for you.
When raising a funding round, you will need to dilute your equity to issue new shares to your investors. Many companies outgrow their initial funding and have to raise additional rounds from venture capital firms. This process results in founders gradually losing percentages of equity in their company, along with reduced control and decision-making power. Founders can mitigate this risk by only raising the amount that’s necessary.
2. Diverts attention from running the business
The process of finding investors and raising funds can take time away from managing your business. Not only do you have to expand your network to find viable partners, but you also have to ensure your business meets your target partners’ standards.
To give yourself enough time to balance managing the company and raising funds, start looking for investors before your business reaches a point where extra funding is critical. Additionally, it’s best to identify problems and address them early in development. Future rounds of funding will become simpler because many issues will have already been reviewed and corrected.
3. Has funding opportunities that can be competitive
There can be tough competition to catch the interest of credible investors. Venture capital firms can often be picky about which companies they invest in since they will likely be working closely with the business. With limited willing investors in a large pool of startups, it can be hard to stand out to get the funding you need.
One option for startups seeking first-time funding is an incubator or an accelerator. They often provide as much as $150,000 in funding and a three-month crash course that prepares companies for growth and future rounds of funding. Startups should also consider angel investment for smaller amounts of funding on more flexible terms.
4. Can be relatively expensive
Giving up equity in your company may seem inexpensive compared to taking out a loan. However, the cost of equity is only realized when the business is sold. Venture capital provides much more than capital, like advice and introductions. However, the decision can still be costly in comparison to other funding alternatives.
For example, two startups both need $1 million and are valued at $10 million. The first company takes out an SBA loan for 10 years at 10% interest, whereas the other raises $1 million for 10% equity. In 10 years, if both companies sell for $100 million, the founders of the first company paid $600,000 in interest for the loan and retained full equity, while the second company gave up $10 million of proceeds from the sale due to the equity dilution.
5. Requires setting up a board of directors
Obtaining venture capital requires some formalities that aren’t standard with other types of financing. This includes setting up a board of directors and an internal structure to oversee operations and ensure the company’s growth. This can limit flexibility and reduce the amount of control that the founders have.
Venture capital firms impose this structure to provide oversight during the growth process and identify any problems that may arise due to acceleration. This structure also gives venture capital firms comfort because of increased levels of reporting and transparency.
6. Creates high expectations for business growth
To ensure a return on investment, venture capitalists will have high expectations of business growth. These expectations are in place with the idea that your business will become valuable enough to be publicly traded on the stock market or eligible for acquisition in the future. This can put high pressure on the business and its team, so it’s important to communicate with potential investors to ensure goal alignment.
Additionally, partners release your funds on a performance schedule. To get access to more capital, you are required to meet performance metrics determined by the venture capital firm, such as revenue milestones and customer acquisition.
7. Comes with the risk of business failure if goals aren’t met
Underperforming companies that fail to meet goals or conditions of the investment can be at risk of losing the business altogether. When founders fail to maximize their shareholder value, neglect the business, or use shareholder funds recklessly, their investors often let them go. Without investor support, it’s unlikely the business will be able to bounce back.
8. Reduces leverage in negotiations
Many startups seek venture capital when it is the only source of funding that can meet their needs. In rare circumstances, there are too many investors interested (which is known as being “oversubscribed”), and the startup has leverage over the terms. However, most startups won’t have much leverage over their investors beyond rejecting their offers. Start your search early to find a venture capital firm that understands your goals and funding needs.
How to decide if venture capital is right for you
If you’re considering venture capital as a source of funding but aren’t sure if it’s the right choice for your company, it makes sense to consider the pros and cons. However, it’s completely understandable if you feel overwhelmed by the number of advantages and disadvantages to consider.
To help you decide if venture capital could be suitable for your circumstances, I’ve summarized some of the key points to think about. If you decide that VC is suitable, you can take the first steps to getting funding by following our VC funding guide.
Your business type and potential
Venture capital investors typically target companies that they believe will have the potential to grow quickly in a relatively short period of time. Timelines can vary by product and industry but can generally be measured by the average historical rate of growth of competitors. You should be prepared to present a business plan that emphasizes this aspect of your business and why it has the potential to scale quickly.
Giving up company equity
One of the advantages of getting funding from a VC investor is that they’ll have a vested interest in seeing your company succeed. The tradeoff, however, is that they’ll often want a percentage of ownership in your company. This is not something that you should give away lightly, as even a small percentage could end up being quite valuable should your company succeed. Also, consider whether you would be okay with losing some portion of control and ownership in your firm.
Lack of debt repayments
Venture capital doesn’t normally require monthly loan repayments. Rather, the closest thing you might get to this is if your VC funding is structured to require repayment in the form of a convertible note. With a convertible note, VC investments are repaid at a future date through liquidity events such as fundraisings or going public through an IPO.
Access to expert business guidance
Getting funding from a VC investor usually also means you’ll get their assistance with managing various aspects of your business. This is done in part because, as the investor, they also have a vested interest in seeing you succeed. Many VC investors will have industry expertise and guidance that can be provided on things like marketing, strategic planning, and more. This can also include getting help with day-to-day tasks such as hiring team members, building and training your employees, and other short- and long-term planning.
Alternatives to venture capital
Venture capital won’t be right for everyone, so you can consider alternative funding sources if you find that VC isn’t quite suited for your circumstances:
- Crowdfunding: Crowdfunding involves raising small amounts of money from a large number of investors. You can choose to repay investors by offering discounts on future products or services, equity, or other types of reward systems. Like venture capital, crowdfunding has its own set of pros and cons you should consider. If you choose to go this route, I recommend using a top-rated crowdfunding platform to publicize your funding request.
- Angel funding: Angel investors are individuals who typically invest their own funds into early-stage businesses with high growth potential. Funding amounts can vary, with terms set by the investor. Typically, they have less capital and risk tolerance than venture capital firms, although they are less likely to want direct involvement in running the business. If this fits the bill, see our guide on how to raise angel funding for your business.
- Funding from friends and family: Borrowing money from friends and family can help you bypass traditional lending requirements for things like credit and income. You can also get more flexibility in the interest rates you pay. However, there are still regulatory requirements to keep in mind. Check out our guide on raising money from friends and family to learn more.
- SBA loans: These government-backed loans can offer some of the most competitive rates on the market. They can, however, take upwards of 60 to 90-plus days to fund and require a significant amount of paperwork to get qualified. Eligibility criteria also tend to be rather strict. Consider getting guidance throughout the lending process from one of the best SBA lenders.
- Bad credit loans: While having bad credit may make it more difficult to get approved for a loan, it’s not impossible. Our team’s recommendations for the best bad credit loans can allow you to get funding with a low credit score and at competitive rates.
- Personal loans for business purposes: If you’re unable to get approved for a loan because of your business credit or finances, you can consider some of the best personal loans that consider your personal credit and finances instead.
- Rollover for business startups (ROBS): A ROBS is a way to access your retirement funds tax- and penalty-free. This requires navigating complex tax rules and regulations, though, so I recommend using the services of the best ROBS providers to offer guidance and protections in the unlikely event an error is made.
Frequently asked questions (FAQs)
There are a few risks involved with raising venture capital. Most of the risk is imposed on the investor, as they won’t receive a return on investment if your business fails or lacks growth. In this case, they lose the funds provided and have limited options to recoup the loss.
One of the major drawbacks of accepting venture capital is having to give up an ownership percentage of your business. For many business owners, giving up a portion of their control within the company isn’t worth the investment.
No. Venture capital funds are given in exchange for equity, rather than standard debt repayments required of a standard business loan.
Bottom line
Now that you know the pros and cons of venture capital financing, you can determine if it’s suitable for your business needs. Although venture capital provides access to a large amount of financing with no collateral or monthly payments, pursuing it comes at the cost of equity. Before proceeding, ensure you explore all of your financing options and factor in your business goals.
