An age-old proverb holds true in the startup funding world: “All that glitters is not gold.”
In the past decade, an entrepreneur’s goal has changed from creating a profitable business to raising a round of funding. Funded entrepreneurs are perceived to be more successful than those who are not able to raise equity funding or, for that matter, not aiming for a capital infusion.
The euphoria amongst founders to “get funded” has reached an all-time high. ‘How to raise funding?’ is searched on google by a wannapreneur even before the individual forms a legal entity to kickstart business.
While it is true that funding gives you more firepower to scale up your venture (and the glamour associated with it), it can at times become a crown of thorns for the funded founder. Some ventures by design are just not fundable. An entrepreneur’s effort of chasing investors in a non-fundable business is a total waste of time – time that could have been spent on strengthening revenue channels.
Before a founder jumps in the capital raising game, here are 13 reasons on why one should reconsider.
1. Your business might not be fundable
Not all businesses are attractive to VCs. Parameters such as founder’s background, scalability of the business, technology, entry barriers, being asset-light etc. form a major component of the investor lens. A large number of startups and SMEs do not fit into these criteria.
At times, your business might not even need growth capital. Brick-and-mortar trading, pure-play manufacturing, and commoditised ventures are some of the examples that are not the right candidates for an equity round. Why waste time when you can make money and grow without a fundraise?
2. Founder’s bandwidth
Capital raise is an intensive process and has multiple steps, starting from creating a compelling pitch, backing it with numbers, meeting investors, negotiating agreements, managing the due-diligence process, and post-funding compliances. The founder is at the epicentre of this.
A fundraise consumes a founder’s bandwidth, leaving very little time for driving business. If you are a single founder, this can be a nightmare as jumping into fundraising can come at the cost of your business performance getting impacted.
3. Control
Even if the investor is a minority shareholder in the company (say 20 percent), and founders are having a majority representation on the board, the investor can still have a decent control over important matters of the company through the reserved matters clause.
Reserved matters gives the investor appointed director a veto over certain key decisions. These decisions are pertaining to appointment or termination of the CXO, changes in the structure of the board, approval of the annual business plan, material variation in expenditure, transfer of IPR etc.
4. Hockey-stick growth vs running the venture at your own pace
You cannot think small when you go to investors. The objective is to pump in capital, acquire customers, and take up a sizable market share.
Funded startups are expected to grow at double digits month on month. Aggressive growth goes hand in hand with funding. Many entrepreneurs may not be ready or tuned in to this thought process.
5. Driving valuation
Growth drives valuation and valuation drives the ultimate exit bounty that investors make at liquidity event. Hence, there is a constant pressure on the founder to ensure growth in valuation.
Subsequent funding rounds need to happen ideally at a higher valuation. Lower value – referred to as a down round – can be detrimental to founder’s equity.
6. Creating liquidity event for investors
Raising a round of capital is just the starting point. Angels and VCs invest in a venture only to exit at the end of five to seven years. An exit event happens through a secondary sale, acquisition, or an IPO. It is the founder’s responsibility to ensure that the investment is taken to its logical conclusion and investors get a profitable exit.
The success of raising VC money is in providing a profitable exit. This journey from first fundraise to exit is arduous. Very few make it to the end. At times, clauses such as put option on the company or the founders as a last resort for investor exit can be very painful for the entrepreneur.
7. Understanding legal terms
A successful fundraise requires maneuvering through pages and pages of legal agreements. VC transactions have fancy clauses and rights such as exit right, drag along, tag along, ROFR, anti-dilution, indemnity etc. While you can always appoint a lawyer to ensure that the founder’s rights are protected, a founder must still spend considerable amount of time learning these terms and understanding the legal aspect of capital raise.
8. One round is not enough
Scaling up requires deep pockets and multiple funding rounds. Time taken to close a round is typically six to nine months. Every round gives the company a runway for 18 to 24 months. This means, the founder must be on road to raise capital almost every year.
9. Cost of capital raise
To raise a round of funding, you must frontload certain costs such as hiring lawyers and experts, due-diligence cost, compliance cost, and even statutory costs such as stamp duty payment etc. Not all costs are success based – some must be incurred upfront.
10. Competing with deeper pockets
When a sector heats up, multiple players can raise investments. Some who have come in after you can end up raising much larger rounds. CACs go off the roof, customers are given freebies, and all that you have built so far looks irrelevant.
Competing with deeper pockets in a heated-up space can be challenging. Constantly innovating and building entry barriers must be taken to another level when you raise money.
11. Reviews, MIS and reporting
Once you onboard an investor, you have to get used to monthly reviews, preparing and sharing MIS, professionally managed board meetings, budgeting, business plan exercises, and reporting key metrics. Reasons for deviation and actions taken are discussed periodically.
While some may say that this is a step towards professionalism, many entrepreneurs find this process cumbersome and are just not used to run business in this fashion.
12. Founder’s remuneration
Post funding, the founder signs an employment agreement with the company. His compensation structure and performance bonus are defined by the board just like for any other employee. This way of functioning can be very different for a few founders who have been used to taking remuneration and claiming expenses in a privately held venture.
13. Mental resilience
To drive growth and valuations, entrepreneurs are often known to put in long hours, sacrifice personal and social life, and make the venture their sole purpose of existence. While it all looks glamourous, it can put extreme pressure on the founder and can have an impact on mental and physical health.
(Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the views of YS.)
