By Ellie Pigott
Venture Capital (VC) can be a game-changer for startups, providing essential capital and strategic guidance to fuel growth. However, amidst the promises and potential benefits, founders often grapple with misconceptions that can shape their perception of engaging with VC firms. In this blog, we’ll delve into three common misconceptions that frequently surface in the startup ecosystem: misaligned interests, unhealthy growth rates, and the fear of loss of control. It is important to note that not all VC’s are created equal, but by unraveling general VC misconceptions, we aim to provide a clearer understanding for founders considering VC partnerships.
1. Misaligned Interests: VC’s Will Put Their Own Interests Before Their Portfolio Companies
One key to avoiding misaligned interests with any potential partners is to be clear in expectations from the beginning. During any initial or diligence meetings with potential venture capital partners, be honest in your vision, perceived feasible growth rate, and personal interests for your company. Tailoring or fudging your answers to better increase your odds of receiving funding will only hurt both parties down the line. Likewise, it is also important to ask your potential VC tough and direct questions about their intentions with the company. Examples include, what kind of growth would be expected if we received funding? What would happen if we were not hitting the expected growth? How have you handled previous difficult situations in your portfolio? How involved are you in your portfolio companies?
A VC’s level of portfolio involvement can often be an indicator of how they handle struggles within their portfolio. A larger, more hands-off VC may be more inclined to cut their losses at the first sign of trouble, while a smaller more involved VC may be more likely to put the time and energy into a struggling company to help it be more successful.
Overall, your venture investors are betting on your success and will benefit more if you succeed. Although they have a duty to create returns for shareholders, creating value for their portfolio companies and founders will ultimately help them to generate a higher return.
2. Unhealthy Growth Rates: VC’s Will Push You to Grow Faster Than What is Best for the Company
High growth rates can be daunting, especially when considering the short time span many VCs are built around. It’s important to understand that not all VC’s are built the same, meaning some are designed around portfolio companies achieving a 30X return in 5 years, while others are created around a thesis that allows for 10X growth in 3-5 years. Doing research on or inquiring about potential VC’s growth expectations is a crucial step in finding the right partner. This is also a great step in considering if your company is a good candidate for venture capital. If a minimum of 10X growth within 3-7 years doesn’t feel feasible with your business model or doesn’t align with your vision and values for the company, you may be a better candidate for traditional financing like bank loans.
As mentioned previously, the most important part of a successful VC partnership and the best way to avoid unhealthy growth rates is clear communication. VCs want to generate a successful return but will structure your investment with an exit number already in mind. These expectations could be adjusted down the road if there is a significant change in market size but will likely come with a plan to increase staff, strategy and general support.
3. Fear of Losing Control: VC’s Will Take Control of My Company
Fear of giving up equity in your company can stem from a variety of concerns, often completely justified, but also commonly misunderstood. Are you nervous that giving up equity will result in lower cash in your pocket when your exit? Do you worry VC partners will exert influence over crucial decisions, and limit your autonomy in steering the company’s direction? Does the possibility of a board takeover keep you up at night? All of the above are common VC misconceptions many founders face around investor control, but are any of these true?
- Giving Up Equity: Many founders have in mind that the more equity they retain, the more money they’ll receive in an exit. This can be true, up to a certain point, which is why the complexity of equity in startups is often compared to pie. Founders tend to think of giving up equity as giving up a piece of the pie, and every time you give up equity, your piece of the pie shrinks. In reality, the pie is continually growing. For example, after two rounds of funding you may only own 40% of your company. But because you took funding and used it to strategically scale, you now own 40% of a $30M business, instead of 100% of a $1M business. In this example, the option with less equity would produce you a higher return. This analogy is great to consider when selecting the right partner. Is the partner you’re adding going to provide an adequate amount of value for the equity they’re receiving?
- Exerting Influence: When vetting potential investments, a commonly heavily weighed factor is the team. VC’s look for strong founders that are experts in their industry. Knowing that you are an industry expert allows VC’s to only get involved at a high level and helps them avoid power struggles with founders. Another structure in place that helps avoid investors having too much influence is the structure of your board. More info on boards below.
- Board Takeover: Has the Sam Altman Open Ai board situation made you wary of board structure? As mentioned above, curating a sound board can be a great way to balance power. Many founders limit boards to contain only one seat per round, this seat typically goes to the lead investor and helps to avoid too many voices in the room. It is also standard for founders to secure their board spot and a seat for other key members through seats referred to as “Common Control Members”. It is also important to classify voting rights amongst board members and designate in your bylaws what specific actions require board approval. For more information on board composition, check out this resource: https://www.ycombinator.com/library/3w-how-to-create-and-manage-a-board
Mastering the VC Landscape:
Navigating the realm of Venture Capital can be difficult and at times nerve racking. VC’s can be a great resource for founders looking to scale, but lack of upfront communication can at times be fatal. To address misaligned interests, clear communication during initial meetings with potential VC partners is crucial. Do diligence on any potential partner and have an idea of where you stand on important issues (company vision, growth rates, board seats, etc) ahead of time.
If you’re interested in taking the first step and exploring VC funding, check out our Investment Criteria and select Apply Now to fill out a funding application!