Advantages and Drawbacks of Venture Capital Funding for Startups

By Fernando Berrocal

High potential startups and growing businesses with little to no experience can be funded by venture capitalists (VCs). This is a popular type of private equity. VC firms buy ownership holdings from new startups in exchange for funding, advice, and assistance. This form of finance may provide business entrepreneurs access to greater sums of funding than they could obtain through traditional options.

Venture Capitalists

Venture capital groups provide insight and knowledge from seasoned startup investors. There is high risk involved, however, since those investors might lose money if a business fails. When it comes to startups, investors frequently place a higher priority on immediate and mid-term success, rather than long-term.  Venture capitalists can help businesses financially and commercially through their support. This enables those businesses to take advantage of market opportunities and make long-term capital gains.

Advantages of Venture Capital Funding

  1. Their advice is priceless.  Venture capital groups may provide crucial business knowledge and advice in addition to backing your startup financially. Typically, the group appoints a board of members; they are permitted to weigh in on business decisions. VCs have a great deal of startup growth experience. They can offer important business advice, complex technical assistance, and other important resources to assist your business to prosper in every way possible.
  2. Their investments are reliable. Government entities impose rigorous regulations on venture capital firms. They are governed by the U.S. Securities and Exchange Commission (SEC) with the same laws as other investments in private securities. Investment banks and deposit-taking organizations are frequently given VC capital. Know-your-customer policies (KYC) and anti-money laundering legislation may be applied. Due to the vast range of established regulations, venture capital investors rarely take part in unethical behavior.

Venture Capital

  1. Potential for growth. Venture capitalists aim to assist businesses in achieving their maximum growth potential. Since bank loans demand collateral - and a payback responsibility - they are unable to do this. On the other hand, VCs take greater risks with their investments.  If you have limited operational experience and significant startup expenditures, it is a smart alternative. If angel investors are optimistic about the company's potential, they may also assume the risk–however, these situations are uncommon.
  2. No need for repayment.  Unlike bank loans or other types of business debts for their business, venture capital funding does not put entrepreneurs under financial pressure to return the debt during the business cycle. 
  3. Easy to locate. Several directories mention venture capital investors for your business. This makes it simple to rapidly and effectively access venture investments right away. Finding venture capital investors nowadays can be done rapidly due to the growing network of digital channels available. Any search engine can be used to uncover venture capital investors in your state, the country–perhaps even the world.
  4. Develop business networks and relationships. Venture capital groups are connected widely throughout the business environment. If startups want to expand and thrive, these relationships may be a massive benefit. These connections may be leveraged to create partnerships and form alliances with potential clients or corporate partners for startups.

Drawbacks of Venture Capital Investments

  1. It’s a long and difficult process.  A thorough business plan should be initially presented by the startup's owner to the investment group. After that, if the venture capital team agrees to fund your organization, they proceed to reviewing this plan methodically.  Eventually, they meet with the applicant in private to discuss it. Then, the information is verified through due diligence. The VC group will release a terms sheet if it has been done. Generally speaking, the process of procuring this type of funding can be a tiresome and slow-moving process.
  2. Diluting control and ownership.  In exchange for a portion of the firm's stock (equity), venture capitalists pour significant funding into businesses. If it's successful, the startup will become extremely profitable for them. The board frequently includes a sizable proportion of VCs who participate in the organization's decision-making and seek the security of their investments. Things might become complicated if the founders and the venture capital group disagree on specific important decisions. These investors must approve all important decisions of the businesses they fund.
  3. Early redemption.  Venture capital groups may choose that the investment is redeemable in 3 to 5 years. Gains from capital are their main objective. Entrepreneurs whose company plans require longer to create liquidity should not use VC for their funding.
  4. A high return on investment (ROI) is required. Some VCs have strict initial year investment return requirements for their clients. Venture capital finance might not be the ideal choice if your startup must provide a strong ROI over some time. Expectations of a better ROI may lead to stress from both parties–and can be harmful to the business.
  5. VCs take some time before making a decision.  For venture capitalists, investing is a high-risk endeavor.  These investors spend lots of time considering and analyzing their investment intentions for a while. Startups can raise money in a big way through venture investment. The lengthy waiting period to get the payments is a drawback.

Drawbacks of Venture Capital Funding

  1. It can be a challenge for VCs to contact you. You may not be aware of how many investment possibilities may be found through an unsolicited email list. Due to this, many business pitches are ignored for a long period. One method to avoid this predicament? Get in touch with a VC through networking.
  2. It can result in undervaluation.  In order to sell their ownership shares, venture capital groups may attempt to pressure business owners into going public. These shares might be undervalued if it takes too long to list. This can also be very problematic for the owner of the business.

In conclusion, there are various methods available to entrepreneurs for financing their businesses–each has pros and cons. Entrepreneurs that choose VC finance mostly have access to more capital than they might otherwise raise. Additionally, it provides insight and guidance from seasoned investors on main business issues and problem resolutions. However, you should be aware that VC investment carries some risks. Entrepreneurs must comprehend the main benefits - and drawbacks - of VC before making a decision.

Ready to bring your startup to the next level? Apply to MassLight’s next batch. MassLight supplies capital and a dedicated tech team. We take equity in return. Have questions? Refer to our FAQ page.

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