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.
5) Company gets directed toward receiving investment rather than becoming a solid company
There is a long-standing trap for entrepreneurs where the goal is to get an alpha product out, get written about in tech publications, and get funded. If I started a company today, I would phrase this differently to something like “pick a direction where the company has a chance to stand financially on its own, has a viral component about it (something people want to link to and recommend to others), and solves some critical need or problem. Of course, I am likely missing something, but the essence of my direction is present.
6) Investors are top of the food chain, but they need to just be a tool for entrepreneurs
One not-talked-about but hugely important job of an investor is PR. Yes, public relations. In public they are all charming, all good brilliant guys who just want to help entrepreneurs. Maybe some do, but most must make themselves known in order to attract the largest number of pitches as they possibly can. Most pitches are bad and an investor needs to see many to find a few of quality which match their own vision of the business landscape moving forward. Therefore while the entrepreneurs are busy making companies, the investors are working hard on PR so that the entrepreneurs come to them, and thus the hierarchy is made: many entrepreneurs come for money to the investors and investors have visibility and control.But investors would be nowhere without entrepreneurs. The CEOs need to rely less on investors and focus on building solid businesses which make life better for someone out there. Entrepreneurs will only succeed if they focus all their energy on the one goal of making a good company. And if they do, hilariously enough, investors will come to them.
7) Negative energy from rejection, meetings with unpleasant investors
Remember it’s a sales pipeline so looking for investment you get rejected quite a bit, and are told that someone else does not see a future in what you are doing. In all honesty, even after pep talks suggesting not to take the rejection personally, wouldn’t that kind of rejection dent someone’s confidence at least a little bit? This negative energy can really demolish a start-up. Do the investors feel bad? Maybe for 3 minutes, if they ever learn that your startup is dead and why. But you will remember that your labor of love lost momentum or partners because they lost faith after rejection. It is much better to surround yourself with people who are not afraid and have the same convictions as you do, and see the same goal as achievable. There may be some delusion, and some of it is even necessary for entrepreneurs. But in this game, you must have the confidence if you are to succeed.
8) Too many dumb, low-quality investors who detract from the business after funding it
The Internet is a fun space, and many people who have made money elsewhere, want to get in on the game. They don’t really know better, and throw 20-100k into some startup which tells them about how hi-tech and cool they will be; and Google better watch out, or buy them soon. The people who make such investments are known as “dumb money.” This is not because these people are dumb. Actually they are often quite brilliant because they are already successful in other fields. But they are just not savvy in the Web space. And thus they throw cash, have lots of patience for 2-6 months, and then want results because the start-up blew through all their cash by then. Worse yet is that these people also have many rich friends who also want to invest in the next Google. After a while there is a bunch of these guys directing things and forcing the CEO to panic and do what is necessary to please them, instead of focusing on building a solid business.It is sometimes even worse with VC firms which are companies that are really good at calling rich investors and saying “hey, why don’t you become a limited partner with our fund, and we’ll multiply your money for you.” They are just OK at screening for good companies into which they’ll put the money they raised. Finally they are not at all prepared to do things like assisting the company or providing advice or connections that makes it run better.
9) Most want control but really have only second-hand, theoretical knowledge
Investors are often people who have been successful at building a company in the past and in a different business landscape, and are now “graduated” into investing in others who have more current view of “the things on the ground” than they do. That is fine, but many investors have big egos, and do not readily admit that they have just a view of things rather than the all-encompassing and correct view, which many of them believe they have. Furthermore, they can be easily if the entrepreneur does not agree with them. It is good if the investor-entrepreneur relationship is collaborative in nature, but the investors who think they know better than the entrepreneur can damage the startup by forcing it to go in a direction that is maybe not the best for it as a company. In fact, because investors tend to fund many companies, they sometimes have strategic interest in a certain direction for the company whereas that direction may not be in the company’s best interest. Additionally, when the entrepreneur has control, she is less under the gun in regard to making mistakes. All entrepreneurs will make mistakes. Some entrepreneurs will make very many mistakes before they succeed. In the end they might get it right or they may not and their project will die. When an investor comes in, it often puts an automatic ticking clock on the lifetime of the founding team as the acting executive team. This is something many entrepreneurs have signed up for in the past only to regret when they learned about the danger of giving up control from experiencing the bad consequence. Unfortunately, it is rare that a new person saves the company. Many investors are deluded enough to think that they add value by kicking out the founders and replacing them with MBA’s or some “suit” who will just collect a salary from them until he fumbles around and gets kicked out as well.
10) Misleading notions of success
Most people think that raising an investment is a success in and of itself. Surely, the “big” investors put lots of money in you and believe in your ideas, and you have a chance to hire out a team, and are on your way to success. In reality it may even be a small failure. Raising investment is a lottery. Some people get lucky. While having money in a bank account is nice, it is sometimes damaging as it gives a false sense of security and causes the entrepreneur to relax and cause an overall slowing of iteration and productivity.