It is without question that many companies have been helped by taking venture and angel investment capital. It keeps operations running, pays for marketing and engineering, and gives the company a lifeline and buys time to get their business moving in the right direction.
Not only that, but a good investor can help make a great company by offering timely introductions to the right people in the industry and really move the needle in a positive direction for an organization. Silicon Valley would not be what it is without venture investment funds.
Unfortunately, there are a number of disadvantages to taking investment and dealing with investors. In many cases, investors see entrepreneurs as pawns in their overall investment strategies, take advantage of the entrepreneurs, or simply leave damaging effects on the company by their presence and advice.
Times have changed and it takes many-fold less resources to build a company than it did 15 or even five years ago. These days, entrepreneurs have many more options and should consider the following potential drawbacks of taking investment when planning for ways to fund their companies.
1) Taking investment restricts future possibilities
Granted, so does debt, or completely starving due to not having money, but typically investors force founders to go after big markets and big demographics. Yet there are many small niches that can result in companies making less than $500,000, $100,000 or even $5,000 per year. Investors would only touch such businesses in extremely rare cases, a team of one or two partners would probably be happy with 500k/year, with a possibility to sell it for a nice valuation, owning 33 percent.
And by the way, many great businesses grow out of serving really well to a small niche and growing out of that into bigger and bigger audiences of people. So when an investor wants you to "go after the ecommerce market," because he understands that a small niche has to be won first, what he is really saying is, "I want to use you as a tool to give me a small chance to hit a jackpot, but most likely you will fail, and I would probably not run my business this way it was me in your shoes."
One person working part-time can easily make one to five thousand dollars a year with simply a content site or a blog. While the investment community has no stake in glorifying such endeavors, entrepreneurs must realize that they do not have to go after huge markets as mandated by most investors, and match the end-goal to the resources they have available to them -- even part-time work for one person can still result in a business that brings supplemental income.
2) Collateral damage: Entrepreneur invests too much in the investor
Most people consider this an afterthought, but it should be a very central and key point. To even get to the investor, and then to pitch to them, the entrepreneurs spend a long time reaching out to investors, getting introductions, preparing for meetings and finally, traveling to pitch.
Imagine that the CEO's time is valued (not cost) at approximately $100/hour, if he spends 10 hours per week looking to secure investment, this is an investment of about $1000 that could go into building the company. Plus at that time, the CEO is not doing anything else to help the company and is not thinking about what can help the business, so there is "collateral damage." All this is an upfront investment by the founding team into possibly getting an investment.
Keep in mind, most companies never ultimately get funded, so it is a big risk taken on by the founding team. Furthermore, even if a company does get funded, in many cases, both the entrepreneurs and the investors will need lawyers, and often the investors take the legal fees they incur right out of the money that was just raised. Be careful.
3) Wasting time looking for the investment in the first place
This is a huge time sink. And what's worse is that getting investment is a lottery (note: in lotteries you usually do not win). It is often random, and depends entirely on factors such as "what did the venture partner who interviewed you have for breakfast that morning" or "does the angel investor share your political leanings" etc. Also, different investors react differently to the materials you put together to pitch them. It is a game of chance, so if your odds are 1 in 500, then you simply have to pitch to 500 investors and you win. That takes time, to set up the meetings, answer their follow-up questions etc. Plus the bad ones never say no, and lead the entrepreneurs on, wasting even more of their time. And by the way, wouldn't it have been better to just spend that time building the business rather than looking for money which would pay for man-hours to build the business?
4) Unfocuses the company from building the product
Looking for investment unfocuses the CEO, because in a start-up, one of the most difficult questions for the CEO to answer is "where is the company really going and how does it define itself?" If the CEO starts aligning it with "we are what the investors want us to be" or "we are going to try to look like something investors like to see," he is in trouble.
Also if a company is funded, to please those who funded them, managers sometimes start to do things in order to satisfy the investors' current demands instead of their customers' demands. Ironically, the same thing is true for many publicly traded companies which shows that the nature of outside, short-term pressure can be very damaging in general.