Pros of Cons in Raising Venture Capital
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What are the pros and cons of raising capital from a VC fund for a corporation?
Seeking outside investment from a venture capital fund is a big decision for a business. While, at first glance, it seems like an amazing opportunity. The venture fund provides operating capital to the business. In return, the business provides an ownership interest to the investors. Unfortunately, there is far more to this relationship than simply the positive aspects. Let’s examine the positives and negatives of accepting investment capital from a venture capital fund.
Benefits of Raising Capital From a Venture Capital Fund
There are numerous benefits to seeking investment capital from a venture capital fund. Here are a few of the primary advantages:
Operational or Growth Funds - The old saying goes, in business, you are either growing or your dying. Sometimes, it is too difficult to grow simply by employing existing business funds or revenue from operations. In such a situation, capital from outside lenders or investors is the only option to achieve growth. Unfortunately, the business may not be able to secure adequate capital through loans. Even if the business is able to secure loans, debt generally has to be repaid in intervals beginning soon after the loan issues. Investors generally invest money without the expectation of any return of capital until the business is later sold, acquires future investors, or goes through a public offering. Faced with the option of running short on operational capital or not taking advantages of opportunities to grow, accepting capital from outside investors may be an excellent option.
Experienced Advisors - A venture capital fund has a vested interest in the success of all of its portfolio companies. As such, the managers of the investment fund are generally willing to work to support the business. These fund managers typically have a great deal of business experience. Business investors are often-times successful business owners (or former business owners) in their own rights. Further, investors routinely review business plans, conduct due diligence of companies, and track the operational and financial performance of all of their portfolio companies. This level of knowledge and expertise can be invaluable to a business. Members of the venture capital fund will generally hold seats on the company board of directors. If this is the case, they will plan an important role in the company’s high-level decision making.
Network - Venture capitalists are generally well connected with other business professionals. Within their network, they likely have individuals who have extensive experience in a relevant area of business. These individuals can be valuable advisors to the business. In some instances, these individuals will assume seats on an advisory board. Unlike the board of directors, these advisors do not vote on high-level corporate matters; rather, they simply review major aspects affecting the company and provide pointed advise to the officers and directors. Also, having these individuals as named advisors of the company is a powerful signaling function to outsiders. It can garner the favor of customers or clients, lenders, and future investors.
Confidence - Running a business can be daunting. In fact, it can be down right scary. In addition to facing the possibility of financial loss, business owners risk personal failure. Sometimes the thought of what friends, family, and strangers may think of or say about us is a major fear. Having professional business people in your corner can provide confidence. Also, in the event of business failure, the fault or blame does not necessarily fall squarely on the shoulders of the business owner.
The Downside of Raising Capital From a Venture Capital Fund
Despite the numerous advantages of securing venture capital, there are also numerous downsides. Some of the notable downsides are as follows:
Reorganization - Investors require stock ownership in exchange for capital invested in the company. More specifically, investors generally require a special type of stock known as preferred stock. In order for a company to provide this preferred stock, the business must reorganize. This means revising the articles of incorporation and developing new bylaws that lay out the rights of all stockholders. While this is a procedural task handled by your legal counsel, it can be a demanding and expensive process.
Costs - People routinely forget that accepting investment requires a number of expensive transactions within the company. Generally, the business will hire an attorney to advise it on the investment transaction. The venture capital fund will also have an attorney to advise on the transaction, to draft the relevant documents, and to conduct due diligence on the company. This process typically generates extensive legal fees. These fees are paid from the capital invested in the company. So, at the outset, the business actually has less funds than those invested.
Control - Investors become owners of the company. As such, they are entitled to the same (or similar) level of control as the original business owner. The investors will have rights to vote on any major changes to the business as shareholders. They have the authority to vote for the election of directors. In many cases, the investors require one or more seats on the board of directors. They may also require special voting rights or other authority as a condition of their investment. Common investor demands include: rights to company information, rights to approve or veto specific transactions, rights to approve future investments or loans, etc.
Ownership - Business owners must come to terms with the fact that they are not the sole owners of their business any more. These investors, who have not poured the same blood, sweat, and tears into the business as the founder, now have a significant ownership interest in the company. This can be a difficult pill for many entrepreneurs to swallow. Further, accepting venture capital is generally a step on the road to rapid growth. More often than not, a company that accepts investment capital will require future investments of capital to meet growth goals or expectations. Investors have special rights that protect them from losing or diminishing their ownership percentage in the company. If the company requires future investment, the original business owner generally loses a far greater percentage of ownership than the first investors. This can dramatically shift the ownership (and control) of the company.
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