Diary of a Social Venture Start-up: Dealing with Venture Capital

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In my last post, I talked a bit about venture capital. It’s a primary method of fueling growth and an integral part of the life of many an entrepreneur. The simple truth is, if you're running a business, a VC can be your best friend. Sure, you're signing over a big chunk of your company, but you're probably getting a check with a bunch of zeros in return.

While the cash is certainly nice, VCs actually bring far more to the table. They'll help you run more efficiently, they'll act as a sounding board, they'll offer invaluable guidance. Additionally, they'll be able to provide you with an extensive network of contacts, from experts in your field to nuts-and-bolts service providers like quality lawyers and accountants. If you're comfortable relinquishing part of your company, the VC experience can be the best thing to happen to a business.

That said, there are dangers. A number of factors can easily strain the entrepreneur/VC relationship. After all, with their investment comes control. Almost universally, a VC will ask for seats on your board. They’re betting on you to succeed and they want to have a say in how things go. And while this is only fair, having a VC involved in the day-to-day can create tension. This post does a nice job of illustrating some issues that can arise.

Both you and your VC want your company to succeed, but that doesn't mean you're necessarily on the same page about how to get there. For instance, a VC needs to make a profit on you fairly quickly. Most venture funds last only ten years. By the end of that time, they’d like to have exited from all of their investments. As a result, it's important to know where you are in the life of the fund. If you're nearing the end of that ten-year period, the VC might be giving you advice designed to get you to sell or IPO sooner than you might want. It might be the right way to go. However, if you were hoping to keep the company independent and continue to grow, you might have a fight on your hands.

I suppose that the most important thing to remember is that VCs always have the power. Whatever benefits they might have explicitly written in the contract, they have the ultimate implicit power card, namely the ability to ensure your company gets no further funding—from them or anyone else. Here's how: Say you've already raised some VC money and your business is looking good so far. There's a good chance you'll need to go and raise more money to help you grow. When this happens, you will absolutely need your current VC to reinvest.

"Who cares if they reinvest," says the naive entrepreneur. "I don't need them anymore. I've got an attractive company now. I'll just go out and get another VC to give me the money." No, you really won't. If your existing VC doesn't continue to fund you, chances are slim that anyone else will. Why? Logic dictates that your VC knows more about you than anyone else does, because they're helping you run the company—they've got the inside information. If you're out trying to raise more money and your VC isn't on board, no matter how attractive you venture might look, outsiders will believe that your VC knows something they don't. It sends huge signals that something's wrong inside your company. It boils down to, "If their own VC won't reinvest, why should we?"

As a result, you’ll need to keep your VC happy. Does that mean doing every single thing they suggest? Of course not. But it does require the ability to compromise. It’s a delicate balance that many entrepreneurs find challenging. However, if you can step back and allow others to play a major role in guiding and transforming your ideas, venture funding might be just the thing you need to take your business to the next level.

The Takeaway: In many cases, VCs are fantastic, but there’s a definitive tradeoff that comes along with the funding. And it’s one that too few rookie entrepreneurs fully consider. Having said that, if you’re comfortable forfeiting some equity—and the control and decision-making abilities that go with it—pursuing venture funding can be one of the best ways to turbocharge your business.