Venture capital advantages and disadvantages for small businesses

“How am I going to fund my business venture?” is one of the first questions you might ask when starting a new business.

Venture capital is one option to consider.

However, it’s worth taking the time to understand how venture capital (VC) works before you accept money from a VC firm.

Then once you’ve got clarity on how things work, it’s worth weighing up the advantages and disadvantages of taking on venture capital to fund your business.

In this article, we look at the pros and cons of venture capital and consider other avenues you might look at besides the VC route to inject funds into your small business.

Here’s what we cover:

• What is venture capital?
• Advantages of venture capital
• Disadvantages of venture capital
• Alternatives to venture capital
• Final thoughts

What is venture capital?

Venture capital is a form of investment that comes from wealthy investors, investment banks and other financial institutions that pool their resources to fund promising early stage companies or startups.

It’s a form of private equity funding.

In return for their investment, venture capitalists receive a percentage of the company’s shares. Their goal is to help an early stage company become profitable fast, while they personally earn a good return on their investment.

Given that, according to statistics, 90% of new businesses end up failing. So venture capitalists risk losing money when investing in businesses that could either succeed or fail.

That’s why venture capital investors typically take a lot of equity and board positions at the businesses they invest in.

Just like any other funding option, you should consider the pros and cons of venture capital to determine if it’s a fit for your business.

We cover them below.

Advantages of venture capital

Access to the funds you need

Qualifying for a loan from a bank is often difficult for new businesses.

So having the option of venture capital will give you another avenue to explore when seeking the funds required to launch or grow your small business.

Get support to build your business

Venture capitalists are likely to offer you hands-on support to help transform your idea into a full-fledged business.

They can do this across different areas of your business, including operations, sales, marketing, human resources and much more.

However, it’s worth doing your due diligence as some VCs will offer more support and time than others.

No monthly repayments

Venture capitalists give you money that you don’t have to start paying back straight away.

Unlike traditional small business loans, venture capital funding doesn’t require monthly repayments. But you will need to give up shares in your company.

However, remember that as your business grows in value, the venture capitalist can sell their shares and earn more than they first invested.

Access to a network of venture capitalists

It can be difficult to juggle running a business and networking. This is an area that venture capitalists can help you.

They dedicate a lot of their time to building networks to help the companies they’ve invested in to grow.

In turn, their networks can help you create your own new partnerships, grow your client base, and even help you access more funding rounds in the future.

Risk management support

Venture capitalist help founders to manage risk, which is one of the key challenges most new businesses face.

You’ll have an experienced team helping you make sound decisions, run your operations, and avoid potential pitfalls in your industry.

Opportunity for fast growth

Venture capital offers fast business growth opportunities. The funds can help you to launch or expand your business quickly and exploit new market opportunities.

When your business enjoys rapid growth, you can outpace your competitors and potentially dominate the market later down the line.

Remember, VCs are also interested in your company’s growth, as this indicates better future returns on their investments.

Disadvantages of venture capital

Surrendering shares of your company

Giving up part of your company to investors is one of the biggest disadvantages of venture capital funding.

It’s worth being aware that VC firms can ask for between 10% and 80% ownership of your business.

While you win from the capital, guidance, and venture capitalists’ network, you also lose some control and ownership of your business.

And the more funding rounds that you end up successfully raising funds, the more equity you must give up.

Additionally, some VC stakeholders may choose to be involved a lot in your business operation to ensure profitability and reduce risk.

High demands from VCs

Venture capitalists are well-known for extremely high demands, including a requirement to see high returns on their investments, which leads to only a small number of businesses winning funding.

In fact, according to research, only one in 100 startups get funding from VCs. So, the biggest hurdle you face is convincing VCs and getting them on board to invest.

Approval for venture capital funding usually involves many steps, including:

• A review of your management team
• The commercial potential for your products and services
• If the potential rewards of investing in your business outweigh the risks.

VCs will also go through your business plan, financial forecasts and everything you have to show the company’s growth potential.

Lengthy process

Depending on the business stage, sector and team running it, the timeframe for venture capital process can range from three to nine months.

That’s because venture capitalists will do due diligence and examine all aspects of your business to ensure they’re putting money in the right place.

They want to ensure a good return on investment (ROI).

Venture capital firms take time to screen startups to determine the viability of your business idea and if the market for your products or services exists.

They’ll want to know how the business can be scaled further for profitability and growth.

They’ll thoroughly review the background of each member of your team and the company’s legal and financial position.

These assessments can take several months before you’re approved for funding.

A lot of pressure for founders

Venture capitalists want to maximise opportunities for a good ROI and do their best to see your company value shoot up as quickly as possible.

With that in mind, they’ll put pressure on you to deliver.

Although a fast-growing company is the ultimate goal, it can be too much pressure for those startups that aren’t ready for the market or can’t fulfil customer demands fast enough.

Alternatives to venture capital

Angel investment

Angel investors are high-net-worth people who usually invest in an early stage company before it’s ready to seek venture capital funding.

Like venture capitalists, angel investors put their money in a company in exchange for part of its equity.

Before investing in your business, angel investors will want to see a detailed pitch that covers the ins and outs of your business, including the product or service you’re selling, financial projections, a business plan, and the background of your team.

Bank loans

Almost every bank has a loan programme for startups and small businesses. Many businesses have succeeded in using bank loans.

But it can be tough for small businesses to get bank loans, especially if they’re in the very early stages.

Bank loans require monthly repayments with interest, which can be difficult for a small or new business without reliable cash flow.

Crowdfunding

Through crowdfunding, you can raise funds from other people on platforms such as IndieGoGo and Kickstarter.

It’s a good option for entrepreneurs with great business ideas and the ability to engage with the crowdfunding community.

Grants

Grants are funds usually offered by a a person, organisation or public entity such as the government.

The main advantage of grants is that the money you receive doesn’t have to be repaid.

You have to make sure you’re eligible to receive the grant you’re applying for.

And the application process can be extensive; you’ll need to have the relevant documentation to show why you need the funds.

Bootstrapping

Bootstrapping is a way of growing your new or small business using your personal funds and resources and the revenue your business generates.

It can be quite challenging, especially if you have limited business knowledge, resources and experience.

However, unlike venture capital funding, you’re in total control of your business and don’t have to sacrifice equity ownership to investors.

Final thoughts

Venture capital allows you to launch, scale, and grow your business using funds accessed from wealthy investors and financial institutions.

It offers several advantages, such as getting the money your startup needs, no monthly repayments, and support and guidance from experienced entrepreneurs.

However, you’ll have to exchange a substantial percentage of ownership equity to your funders.

So make sure you understand the advantages and disadvantages of venture capital before opting for this form of business funding.