Avoiding Venture Overdose
At its best, venture capital can be an amount of new cash from new advisors, both additive, short-term growth resources. At its worst, venture capital can resemble these benefits but turns out to be an over infusion of cash - potentially crippling to a company - from some new advisors with whom founders were actually misaligned from the jump. In the fall of 2016, Eric Paley wrote a meaningfully transparent piece on the toxicity of overindulging in venture financing titled venture capital is a hell of a drug. In his post, Eric reinforces the point that the outcome for startups that inhale supersized venture rounds early and often is usually the graveyard, not the pantheon. Nonetheless, many startups still fail when blind to the longterm downside of too much venture money.
It's counterintuitive in a consumer culture to believe More < Less. When it concerns money, this equation runs diametrically against societal perception of value. And so it is for technology startups and venture capital. Offers of larger and larger investment must be a good thing, right? Don't get me wrong, its challenging to argue against all-powerful pots of gold that can be elusive to startup founders. However, the brutal effects of too much venture investment are often obscured by the same human error that makes us covet more of everything. All parties get cartoon dollar sign eyes. The press sings your praises for landing a mega round; your employees get excited about more resources and larger salaries; many who only see the headline anoint you as rich and tell everyone they know that you're crushing it. Adoration is a human want and for hardscrabble entrepreneurs its tough not to be drawn to a spotlight and stage that's calling for you. And, of course, in the aftermath of a gigantic venture raise, there are literal benefits to founders as well - notably some form of significantly improved compensation.
In keeping with long-term value over short-term financial windfall, there are some questions you can ask of any investment offer to help you make a final decision within a sane bounds of benefit to your company:
Do you really need this much money?
This one should be an internal founding team question to discuss. No doubt, it's hard to resist fitting future scenarios to the money offered. But up to a ceiling of the no bs, most immediately achievable forward growth rate, work back to realistic maximum possible operating and capital costs for the 12, 18, 24 months ahead. Give yourselves a 10-15% buffer, or something within reason for your company, to account for unforeseen costs and/or a breakaway growth trigger.
Do they really believe you need this much money?
Before a specific amount of capital is suggested, it's reasonable to ask the firms offering funding to collaborate with you to understand what amount of capital will achieve an optimal future for your company. After you receive a term sheet with investment numbers defined, it is reasonable to ask the firms involved why, at the stage your business is today, this amount of capital will achieve an optimal future for your company.
Some of the best firms will have already run through future outcome scenarios based on different amounts of capital invested. In those cases, you should feel more confident in a true alignment with potential new investors around a large cash infusion as you make your decision about taking new money and how much you'll take. The point though is not to push VCs to do more work or show their work done. The point is to help you build conviction in the decision to take a large investment. Firms that cannot provide insight into why their offer is the healthiest choice for your company should give you pause. Sometimes, VCs have too much money to deploy and are eager to record paper valuation markups in their portfolios, sometimes at the expense of sound business decisions for the startups they've backed. Sometimes, firms just get competitive and want to win the deal so they outbid one another and your funding round gets bigger and bigger, for no reason that's related to your company. Pushing potential new investors on this question and related exercise should help provide a fuller picture of the motives behind an outsized venture financing offer.
Do they really believe in you, your business, and its continued potential?
This is a more qualitative alignment consideration. Understanding that you only get so many interactions with the people behind the capital before an investment offer is made, you should ask them questions that probe for their excitement and conviction in your specific company and your vision. And its perfectly fine to push them beyond positive overtures, buzzword regurgitation, and cordial niceties. Naturally, you always want investors that believe in you through thick and thin. Often, investors do things like 'chasing heat' or 'taking a flyer' in which they want to invest in you primarily because their peers are (chasing heat) or primarily because they don't want to miss out on some future exit (taking a flyer). If firms are offering you money without discernible interest and belief in what you've built and where its all going, that should give you pause.
A common VC advice soundbite is 'raise as much as you can' or 'raise it if you can'. Its easy to have a head-nodding immediate reaction because it makes practical sense at first blush. Upon deeper consideration, its really only valid in a few cases, the most common being when the external financial markets signal that you should or that you have to 'raise as much as you can'. Examples are an impending economic recession or a tech-startup bubble bursting. Here the advice is to raise more now because you might not be able to in the near future. In the many, many other cases when this advice is given its not correct and it has become so generalized as to disregard any one company's specific circumstances. As hard as it can be in practice to rationalize saying no to more, endeavoring to be more pragmatic and honest in consideration of a large venture investment will serve you and your company well for years to come.