Before you pursue venture capital funding, it’s a good idea to consider all possible benefits and drawbacks. Venture capital advantages and disadvantages include:
| Venture Capital Advantages | Venture Capital Disadvantages |
|---|---|
| Offers access to larger amounts of capital | Reduces ownership stake for founders |
| Lacks monthly payments | Diverts attention from running the business |
| Comes without the need to pledge personal assets | Is relatively scarce and difficult to obtain |
| 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 | Puts underperformers at risk of losing their business |
| Assists with raising future rounds of funding | Reduces leverage in negotiations |
If you require more guidance on venture capital, refer to our guide on what venture capital is and how it works.
Advantages of Venture Capital
Obtaining venture capital has a number of advantages. For fast-growing startups wanting to scale quickly, it might be the only viable option. Besides money, venture capital firms also provide input and introductions to potential future investment partners. They may also help secure future rounds of funding.
1. Offers Access to Larger Amounts of Capital
Many startups seeking small business loans may only qualify for $5 million or less in traditional financing. Additionally, meeting banks’ eligibility requirements for lending products can be difficult.
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 let you obtain.
2. Lacks Monthly Payments
When a venture capital firm invests in your business, it will do so for equity in the company. This means that, unlike with small business and personal loans, you don’t need to make regular monthly payments. This frees up working capital for your business, allowing you to reinvest by improving products, hiring a larger team, or further expanding operations.
3. Comes Without the Need to Pledge Personal Assets
Many startup funding options will require founders to pledge some form of personal assets as collateral. Meanwhile, most venture capital agreements will not require a pledge of personal assets when the agreement is drafted.
4. Provides Expert Business Management Assistance
Many venture capital partners have experience scaling companies, solving day-to-day and longer-term problems, and monitoring financial performance. Even if they don’t have a startup background, they often have experience with assisting startups and serving on the boards of as many as 10 at a time. Their guidance can help you hire the right people, navigate risks, and get your company on the right path to growth and success.
5. Comes With Networking Opportunities
Partners at a venture capital firm may spend up to 50% of their time building their network to assist the companies they invest in. 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
Most venture capital firms have a public relations team and media contacts, and it’s in their best interest to get exposure for your startup. 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
Venture capital firms are interested in seeing your company raise additional funding at a higher valuation as it increases the return on their investment. They can introduce you to additional firms that can better assist you at later stages and provide additional funding. 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 the prospect of raising large amounts of capital for business growth is tempting, receiving venture capital means giving up some level of control. 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
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.
Many startups seek venture capital when it is the only source of funding that can meet their needs. In rare circ*mstances, 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 besides rejecting the deal. This can be mitigated by starting your search early to find a venture capital firm that understands your goals and funding needs.
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.
Because venture capital partners are investing money that belongs to outside contributors, they typically put startups under a thorough screening process. This happens in two stages. First, they will evaluate your technology and business fundamentals to determine if a market for your product exists and if your business can be scaled. Then, venture capital partners conduct a more thorough review of your team’s background and the company’s financial and legal position.
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. Is Relatively Scarce and Difficult to Obtain
According to a report by the National Venture Capital Association, United States startups made approximately 16,000 venture capital deals by the end of 2022. However, about 69% (or 11,000) of these deals had already received venture capital in the past. Venture capitalists point out they receive about 1,000 proposals for every three or four companies they fund.
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, the other raises $1 million for 10% equity. In ten 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
When you get venture capital funding, you’ll be required to set up a board of directors and a formalized internal structure. Both facilitate growth and transparency for the company, enabling it to scale. However, this can limit the flexibility of the company and reduce the amount of control that the founders have.
Venture capital firms impose this structure to provide governance oversight and help diagnose any problems. At a faster pace of growth, problems also arrive more quickly and need to be fixed before they get out of control. This structure also gives venture capital firms comfort because of increased levels of reporting and transparency.
6. Creates High Expectations for Business Growth
To get a return on their investment, venture capital firms need your startup to grow until it becomes valuable enough to get acquired or publicly traded on the stock market. These expectations often increase the already high pressure that founders experience. Founders must communicate with their investors to ensure that they are aligned on goals.
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. Puts Underperformers at Risk of Losing Their Business
Founders who are underperforming can lose their business. When founders fail to maximize their shareholder value, neglect the business, or use shareholder funds recklessly, their investors often let them go.
To minimize this risk, founders should accept their boards’ advice and communicate frequently about plans and goals.
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 circ*mstances, 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.
Alternatives to Venture Capital
Venture capital is best for companies needing funding to scale quickly in exchange for equity. If your company is still growing, you can consider the following alternatives.
1. Business Lending Products
If you don’t mind pledging collateral or monthly payments in exchange for funds, it may be more optimal to choose small business lending products over venture capital funding. It is typically easier to find and qualify for small business loans. Additionally, unlike venture capital, business lending products do not require you to give up equity or business control.
Read our guide on how to get a small business loan for tips choosing loans and lenders.
2. Angel Investors
Angel investors are individuals who invest their own money to support the growth of a business. They typically invest in early-stage startups with high growth potential. Angel funding investment amounts can exceed $250,000.
Because the funds come from one source, angel investors typically have less capital and risk tolerance than venture capital firms. However, they’re also less likely to want direct involvement in running the business.
Refer to our article on what angel funding is and how to get it for a more detailed breakdown.
3. Revenue-based Financing
Through revenue-based financing, you can borrow funds from investors by promising a set percentage of your monthly income as repayment. This can be a great alternative to venture capital because it doesn’t require founders to give up equity. Your payments are variable and based on the revenue the company generates, which is great for launching a product.
Loan amounts are available up to $3 million, and startups can take advantage of quick online applications. Our article on how revenue-based loans work provides more information.
Bottom Line
It’s important to evaluate the pros and cons of venture capital before starting your funding journey. 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. And while you will also receive advice and guidance, you must give up a measure of control over your business in the process.
