Does every startup need VC capital?

money

Virtually every startup I mentor at MIT seems to believe that they need to raise outside capital immediately. While there are few notable exceptions, it seems like the entrepreneurial culture puts a premium on raising venture capital – it’s sort of the startup seal of approval. But Peter Strack argues against the tide in his Forbes article Why You Shouldn’t Always Raise Money For A New Business. Here are his arguments annotated by my comments:

You Can Keep 100% Of Your Company

As a notable VC once reminded me, “They only make 100% of the company, so act accordingly.” But there’s a more important factor than how much equity you have upon a liquidity event, that factor is control. Once you take a VC investment you will be giving up a board seat to that investor. Since first rounds are often syndicated, there may be two or more VCs looking for board seats as well. Generally you can get two insiders on your Board, the founder and another member of senior management, to balance the two VCs, but you aren’t going to have the freedom and independence you had as a new founder. Keep in mind that you may be working with these investors for years, so make sure the individual partner and their fund are going to contribute more than money – contacts, advice, feedback, and support when times are tough.

Bigger Is Not Necessarily Better

While tech startups often need engineers to build their product and these engineers typically will want a salary, which can increase the pressure on the founder to raise money. But keep in mind Mr. Strack’s admonition: Premature scaling can cause technology startups to fail. And 46% of professional, scientific and technical services companies close within the first five years.

You Learn So Much From Doing It Yourself

I consider learning to be job one for any founder. No matter what your academic credentials, not matter what hot startups you’ve worked at, being the CEO of a startup is very hard. The longer you can stay in control and learn the ins and outs of running your company the more you will learn, and the more valuable the company will be. Of course, there is a point of diminishing returns where you will need to bring on partners and staff but premature hiring is almost as dangerous as premature scaling, actually it’s a subset of that problem.

So what does Mr. Strack advise in lieu of taking on investor capital?

• Hustle – hard work is just the ante. To create value in your enterprise you need to be productive. That means being absolutely ruthless on how you spend your time, your most valuable asset as a founder. Focus on productivity not activity.

• Be smart with the funds you have – I was taught by the VCs to stretch the dollar. For example, rather than hiring full time staff who require not only salaries, but benefits and stock options as well, use consultants and contractors to work on a project basis.

And let me add one other point: look for leverage. As Archimedes said, “Give me a lever long enough and a fulcrum on which to place it, and I shall move the world.” Examples of leverage include hiring interns instead of consultants and contractors, finding a law firm that will defer your fees until your first round of investment, and sub-letting office space from another tech company that may have a surplus and be willing to offer you a cut rate.

There is nothing wrong with raising capital, but be strategic about it. The best time to raise capital is when you don’t need it. Believe me, investors can smell desperation a mile away and they will take advantage of it. And keep in mind it can take six months or more between starting to raise capital and the check clearing the bank. So start understanding the VC climate in your region. Get to know some VCs informally. But just because you are studying something doesn’t mean you are committed to it. The Boy Scouts’ motto applies to raising capital: Be prepared.

Author: Mentorphile

Mentor, coach, and advisor to entrepreneurs, small businesses, and non-profit organizations. General manager with significant experience in both for-profit and non-profit organizations. Focus on media and information. On founding team of four venture-backed companies. Currently Chairman of Popsleuth, Inc., maker of the Endorfyn app for keeping fans updated on new stuff from their favorite artists.

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