Venture capital money isn’t always good for business

Money from venture capitalists isn’t always a good thing for your business. Some tech companies are worth billions of dollars but most of them are not and should not be treated as such.

Web development company Basecamp CEO Jason Fried said that raising too much money ended up stunting growth.

“It’s like watering a plant with too much water, you end up killing it,” said Jason.

“The reason venture capital “kills more businesses than it helps” is because the pressure to grow crazy-fast means companies keep raising money to keep their growth rate up. That, in turn, means they rarely have the opportunity to learn how to spend money in a disciplined, sustainable way.

The thing about venture capital funding is it defeats the purpose of being your own boss and running your own business. One of the reasons for any startup is to control your own company, to work for yourself and to collect your own paycheck and consequently venture capital funding just makes you answerable to somebody else now.

Eric Paley, managing partner at the VC firm Founder Collective and co-founder of 3D dental impression company Brontes, explains why VC funding can be so bad for a startup that it’s actually toxic.

A healthy proportion of startups fail. The VC industry is built on the idea that it doesn’t really matter if most of the companies you fund go belly-up because you’re hoping that one of them will turn out to be the next Uber, and more than make up for your losses on the rest.

VC’s aren’t interested in small startups which have slow, steady growth. They want accelerated growth and scale. Ironically this can kill many a start up and VC simply chalk it up to a loss while the company owner is left with no company anymore.

There is also something called a marginal dollar problem. Hiring an overpaid salesperson who brings in new business but not nearly enough to justify his or her paycheck is one good example of how the pursuit of growth at all costs can destroy a company’s long-term viability. That might be a worthwhile tradeoff for a VC, but it probably isn’t worthwhile for a founder.

Paley also gave the following scenario as an example, accepting venture capital funding inevitably means giving up some control of your startup, but at least you’ll make more money than you would without it–right? Well no, not necessarily. In fact, he says, it’s quite possible that you could sell your startup for $1 billion but wind up with less money in your pocket than someone who sold for $100 million. That’s because it will take several rounds of funding to get to that billion-dollar valuation, and at every round you’ll have to give up more of your stake in the company. You’ll wind up with a smaller piece of a bigger pie, when sometimes the big piece of a smaller pie is worth more.

To illustrate, Paley compares the sale of the Huffington Post, reportedly for $314 million with that of TechCrunch for $30 million. Because of the dilution effect mentioned above, Arianna Huffington received about $18 million from the Huffington Post sale, while TechCrunch founder Michael Arrington wound up with $24 million. “To a VC, TechCrunch’s sale would have been a ‘loss,’ and many VCs would have pushed Michael not to sell. Yet Arrington was more successful, financially, than Huffington,” he writes.

And that’s the whole problem–what’s best for VCs often isn’t best for founders. When these conflicts arise, do you believe they’ll put your interests ahead of their investors’ and their own? If not, maybe you shouldn’t put your startup’s fate in their hands.

source: TechCrunch; IncSoutheast Asia, Recode