Advantages & Disadvantages of Traditional Venture Capital
The benefits of venture capital can be attractive, especially if you’re focused on accelerating the growth of your business quickly. But isn’t right for every business. Here’s our take on the advantages and disadvantages of venture capital - written as always, with ambitious, cause-driven entrepreneurs in mind.
First let’s look at some of the advantages of venture capital as a source of finance:
Access money to invest in growth
The US Bureau of Labor Statistics estimates 50% of small businesses fail within the first four years. Growth capital can help you survive those early years. Here are some examples:
Facilitate cash flow for building mission-critical infrastructure fast: hiring the best talent, accessing mission-critical equipment, unlocking innovation and R&D, buying access to reliable, current customer data.
Good data isn’t cheap but will help generate sharp consumer insights that will inform product development, enhanced targeting of marketing, refine your business model, and set realistic growth projections.
Supercharge your board
A well-connected, intellectually engaged board can transform a business by giving you access to high-quality personal networks. Some examples:
Access to Limited Partners and well-established, successful experts with decades of experience. These are the people who can sharpen your strategy, show you the quickest route forward, and avoid unknown traps.
Access contacts with the very best production partners - build those third-party business relationships that ensure the quality, performance, and availability of your product or service.
Having the funds to hire the best colleagues is one thing, finding them in the first place is quite another. Recruitment can be expensive, so anything that empowers your personal recruitment network is worth considering.
Access more funding
One of the big benefits of venture capital is it can help you access further sources of finance. Venture capital involvement is seen as a seal of approval by many: from banks to private venture capitalists and corporate venture capital. The truism is: Good money follows good money. Never underestimate how closely the investment community watches itself.
Focuses you on an exit
Not everyone wants to be in it for the long haul. That’s a personal choice every entrepreneur makes; project by project, business by business. It’s OK to be opportunistic, especially when you’re trying to do good in this world. Effecting positive change and doing well is the name of the game.
Venture Capitalists coach all of the brands in their investment portfolio to do as well as possible as fast as possible. If you’re matching those targets and leveraging the infrastructure the VC is supplying it can be a wild ride, incredibly exhilarating and personally rewarding. Afterall there’s nothing like a clear time-based goal to focus the mind.
Sounds good right? So what are the disadvantages of venture capital?
Exit economics can be brutal
Most VC deals are skewed in favour of the investor: The moment you take venture capital money you’re entering into a pact where you have a fixed amount of time to at least triple the value of your company and exit.
Venture capital funds work to a predetermined fund horizon, at the end of which they promise to return their original fund value plus profits to their investors (pension funds and the like). The fund horizon is typically eight years. Get into the fund early and you could have at least five years. If you’re unlucky and enter the fund late into it’s like you could have a lot less time to achieve the same goals. Don’t underestimate how hard that can be.
Venture capitalists love to hype valuations. By giving you more money they’re forcing you to be a moonshot - a one in a decade exit. If you take money at a high valuation, invest heavily, but miss the growth targets you could get wiped out thanks to a huge cost base and burn rate. Thereby leaving you with an uninvestable business and a tarnished reputation.
If you fall behind growth targets the VC will force a recalculation of your company’s value downwards. In this situation, you can expect your stake to be diluted first, not the venture capital fund’s because 99.9% for sure will have insisted upon a ratchet in the deal.
The portfolio game
Venture capitalists are masters of data and statistics. They operate a portfolio business model because statistically it’s proven to be the best way of minimising their investment risks. Here’s how it works: The VC makes ten investments and pushes all of them to be moonshots, knowing full well that statistically a high percentage of their investments probably won't make it. But if one or two do the potential upside more than covers the failure of the others. There’s never any benefit for venture capitalists to be cautious when operating a portfolio strategy. More money, more risk, more potential growth. They don't care if you’re one of the businesses that failed. They don't care what happens to you if you get wiped out. They expect a high failure rate.
Network access overpromise
Venture capitalists so often fall short of delivering the added value they promise because the truth is there aren’t enough experts to go around. The best mentors only have so many hours in the day. The best production partners reach capacity quickly. The best candidates get hired first.
The risk is as follows: The growth goals and performance metrics placed on your business will stay high regardless of whether you get the attention the Venture Capital fund promised or not, and statistically, you’re more likely to miss the expertise than receive it.
Game-changing ideas often take longer
The portfolio game is amoral. It only sees blind growth, not the consequence for people, society or planet. What if one of the ‘failed’ businesses has positive, world-changing, long term potential? What if that business idea just needed a little longer, a little more nurturing to hit its stride? And what if the entrepreneur behind that business just needed a bit more assistance to find their feet?
The best long term investments might take slightly longer than the standard fund horizon, might not quite make the three-x minimum exit value in time. Your business might not be an instant moonshot. But there could still be huge value ion what you’re trying to do. At The Craftory we recognise that value.
The Craftory is different
The Craftory advantage
At the Craftory we offer responsible, mission-driven business an alternate path. Our ultimate purpose is to amplify the long term success of your brand. We believe it’s possible to do well and do good at the same time.
To find out more about our approach to growth capital, permanent capital and cause capital check out our short film exposing VC money deathtraps.
This post was co-written by Ernesto Schmitt, JP Thurlow and The Craftory Deal Team.
The Craftory, the alternative investment house on a $300M mission to back the world's boldest CPG challenger brands.