If you’re a small technology-based business and you want to grow, at some point you’ll need more money than you can raise from operations, or borrow from family and friends. That’s when you will need to turn to professional investors, in the form of a venture capital or private equity firm that will inject cash in return for a share of the business.
But which is the best option, and what are the risks and rewards of each?
“The biggest difference is that a venture capital firm will typically invest, for the short to medium term, in companies at a relatively early stage of their development, when the risks of failure are higher”, says Corporate Finance Attorney Adrian Dommisse. Many investment companies will either fail, or just putter along without doing anything spectacular.
To compensate for that risk, the successful company had better do spectacularly well – and so the typical VC will want to exit within three years, for perhaps ten times their initial investment.
As a result, it’s an understatement to say that a VC investment comes with some strings attached; they’re more like heavy-duty industrial cables. Strict performance requirements are standard, as are explicit dividends, determined upfront, which accrue until they can be paid. The VC will typically also demand the right to liquidate their investment – which may require the right to sell the company as a whole.
Also, don’t expect that as the founder you are automatically the right person to continue as MD or CEO. Part of the value a VC brings is to scale the business, and identify roles within the business (however senior) that need specialised managerial skills. Successful VCs are not, in general, cuddly sorts of people. It’s their job to be hard-headed to the point of ruthlessness; there is, after all, a lot at stake.
So inviting and accepting a VC investment is not a step to be taken lightly, or because it’s some kind of startup status symbol. The purpose of VC is to provide the funds you need to grow, and so the investment is not a sign that you’ve made it – it’s the cue to work harder and more seriously than ever.
The typical private equity investor, on the other hand, has a slightly lower appetite for risk. They are more likely to take a five- to ten-year view, investing in a company that already has an established track record and can offer good turns – if not the spectacular ones demanded by the venture capitalist. A private equity investor will also bring a wider range of skills to the board.
On balance, if you can possibly afford to self-fund for just a little longer it may be worth hanging in there until you become worthy of the private equity funders’ attention. If you know that your growth ambitions are doomed to fail without that early cash injection, go for the VC option. But in either case, keep your eyes very wide open – and take all the experienced advice you can get.