Many small business owners assume that outside investment from venture capitalists and angel investors is the only way to fund their startup. In reality, venture capital is not common, and over 90% of new businesses will not attract this type of investment.
Investment is not an entitlement and is often a difficult process, especially if you are yet to make a profit. Outside investment also has a number of distinct disadvantages, so you really should consider whether you need it. Hint: it’s not worth it for most startups.
The Downsides To Venture Capital
Venture capital or angel investment is a way to raise relatively large amounts of capital in order to grow your business. The deal usually involves giving away an equity stake in your company, meaning the investor will own an agreed percentage.
Before you give away 30% of your company, think hard about whether you need to raise this capital. Giving away ownership early on means you could make less for yourself in the long run, but it also means giving away control. Investors want to have input and drive your company’s direction, and so you will have to negotiate, compromise and even meet milestones to satisfy them.
If you take outside investment, you will have less freedom to grow your company in the way that you want it. Pretty soon you will need to manage your investors, taking the focus off the customer. That’s if you even secure venture capital. Seeking out investors costs a lot of time and money, and has a low success rate.
Sometimes it’s just an all-around better idea to keep the company lean and maintain control. Grow slowly and organically, in line with your sales and profits. Bootstrapping will allow you to refine your business plan and processes, keep your overheads and burn rate low, and therefore expand with less risk and without the need to sacrifice equity.
Even if you’ll eventually seek venture capital investment, it’s better that you prove your concept and business model by earning a profit. It’s much easier to pitch a company that is already successfully making money as investors can examine ROI to make a decision, and later on, you will have more leverage and the ability to secure fair deals for less equity.
If you decide that the best course of action is not to give away equity in exchange for an outside investment, then there are plenty of alternatives available.
Traditional lenders, such as banks can offer small business loans. The terms will depend on factors such as credit score and collateral. If you only require small amounts of capital, personal loans or even bad credit loans may be more sensible than giving away a percentage of your equity. Calculate costs and work out whether it’s a valid option before proceeding with loans.
Another common way to raise funds is self-investment. The startup owner puts a portion of their own money into the business or raises their own funds. Think of this as a vote for yourself. If you don’t want to put your own money in, you can’t really expect investors to be keen!
Friends and family are also a great option. This is a form of outside investment technically, but this way you can give away equity or deals to your loved ones in return for funding. Crowdfunding extends this idea to strangers, and you can give away products or services instead or equity.
Once you get going, one of the best ways to gain funds is by reinvesting profits into areas that need it most in order to grow. Use cashflow from operations and aim to maximize profits. As mentioned earlier, this is one of the best ways to grow naturally.