Startup founders may dream of landing their first big venture capital investment — a significant cash infusion to fuel their vision, raise the company's profile and reinforce their credibility. The investment could well bring experienced mentors whose expertise and connections provide guidance and further support. What's not to love about all that?
In reality however, while VC backing can be fruitful, it's not the best move for every company. Other financing avenues can sometimes provide capital without the drawbacks that venture investment can bring.
"A startup may decide to pursue alternative financing because of a desire to scale the company at an organic pace," said Nichole Walker, City National Bank senior wealth planner.
"Once a startup seeks VC financing, it faces significant pressure to achieve profitability quickly, to scale at a rapid pace to possibly attract an acquisition deal from a major company, to dominate the market, and/or to provide liquidity to investors on a timeline that may not be in line with the startup's natural growth trajectory," she said.
She cited consumer goods startup Brandless, which reportedly has experienced internal issues this year, including a CEO change, amid pressure from its major investor, SoftBank, to become profitable.
When you welcome money from investors, you may give up some control over your startup's trajectory and ultimately, its destiny.
Even day-to-day business decisions may fall outside your complete control once a VC firm invests in your startup. This can become a major hindrance if investors and company management hold conflicting visions or strategies. And some founders may be uneasy about sharing control with anyone, even backers with similar goals.
Investors are taking an equity stake in your venture, which reduces your share of the profits and potential payout down the road — and VC investors will certainly seek a payout in a few years, via an acquisition or IPO.
Pursuing venture backing, and then working with the investors once they're on board, can gobble up a startup leader's time, energy and focus. If you've made the right VC connection, that time and energy investment may well be worth it for you.
But if VC support isn't the right path for your company, there are a number of alternative funding sources to choose, including bootstrapping with your own funds until your company can operate independently.
The brothers who started San Francisco-based software firm Less Annoying CRM a decade ago took the bootstrapping route, a decision that co-founder and CEO Tyler King explained at length on the company's website, laying out the possible pitfalls as well as the benefits. Even a successful VC experience didn't appeal to him.
"I personally am horrified at the idea of putting in all of this hard work to build up a company only to exit and having to start over from scratch, but I have some good friends who think that sounds great," King wrote.
To bootstrap the company, he and his brother worked other jobs at first, with one employed full-time and devoting his nights and weekends to the startup, and the other working part-time as a consultant to support himself while building the business.
He noted that entrepreneurs can find any number of ways to bootstrap their companies, whether they tap personal savings, live with their parents for a while or offer consulting services until they have the funds to develop products. Additional sources for early-stage firms, King wrote, include angel investments from wealthy individuals.
City National Bank's Walker detailed several other funding alternatives that entrepreneurs might consider:
Investments or loans from those close to you "may be far less onerous than traditional financing," including VC investments and commercials loans. And the repayment terms, including the time horizon, can be more flexible, Walker noted.
"However, there may be more stress in repaying the loan or returning the investment," particularly if the loved one helped you out by tapping into home equity, going into debt or taking other actions that could jeopardize his or her financial standing, she said. "There may be pressures to ensure that the enterprise reaches profitability sooner. "
This is a new form of VC financing that combines debt and equity funding, in which the startup agrees to share a percentage of future revenue with investors in exchange for up-front capital.
This arrangement ties loan payments to monthly revenue, requiring the company to repay investors with a fixed percentage of revenue and provide a fixed return on capital.
"The advantage of this type of financing is that it provides the startup entrepreneur with more flexibility and control over the enterprise and the ability to determine an organic and appropriate path to profitability without the pressures associated with traditional VC firms," said Walker. Also, entrepreneurs don't have to give up as much equity under this plan.
Because there are more traditional VCs than revenue-based VCs, startups may have limited opportunity to find this type of financing, she said.
TechCrunch recently described revenue-based investing as an "option for founders who care about control."
This unique and growing source of startup financing can be a good alternative, although the amounts raised may be insufficient to meet your firm's financial needs for long.
"It may be beneficial in the short-run, but the likelihood that it will sustain the company through a longer life cycle may be small," Walker said. "Additionally, this method of financing oftentimes requires that the investors receive not just a financial return on their investment, but also an actual functioning product or service to which the investor would have access. The startup may need to ensure 'proof of concept'' earlier than anticipated."
Entrepreneurs may secure a loan, or loans, by tapping into a number of sources, such as borrowing against their residence through a home equity loan or credit line, or leveraging other assets.
"The downside risk is an inability to repay the loan," or a requirement to repay it before the company generates revenue, Walker noted. "Pursuing this type of financing may jeopardize the entrepreneur's entire finances, which may cause a ripple effect," she said.
City National offers a variety of personal and commercial loans, including asset-based lending, which allows a business to secure financing based on a percentage of the value of its accounts receivable and inventory. It also offers flexible revolving credit lines for companies at least three years old.
Whatever route you may be considering to find cash to support your startup, City National's commercial bankers and wealth planners can guide you toward a financing decision that best suits your personal and business situation.
This article is for general information and education only. It is provided as a courtesy to the clients and friends of City National Bank (City National). City National does not warrant that it is accurate or complete. Opinions expressed and estimates or projections given are those of the authors or persons quoted as of the date of the article with no obligation to update or notify of inaccuracy or change. This article may not be reproduced, distributed or further published by any person without the written consent of City National. Please cite source when quoting.
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