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The pitfalls of venture funding

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As the venture funding landscape continues to flourish, entrepreneurs who want to build a sustainable business should proceed with caution before heading down the VC path.

As a veteran in the startup space, I’ve done and seen a lot. As a result, I’ve become educated about the pros and cons of venture funding, along with the keys to understanding when it’s the right time to get outside investment.

First and foremost, it’s important to remember that when you take on outside capital too early, you’re learning on expensive, dilutive capital (read: You’re learning on other people’s money). In order to secure this money, you’ve laid a groundwork of assumptions about the business and now need to deliver on those for your new investors.

Customers before capital

Most entrepreneurs understand the importance of getting early customer feedback on your core value proposition, so you can iterate on your offering until you’ve got it right. From there, be sure you know if you’re growing/funding the company based on actual paying orders from early customers, or if you’re using a metric other than revenue (i.e. number of daily users) and relying on funding sources to support the company while it confirms its true business model.

So what comes before capital? From my perspective, start by signing up critical first customers to help you hone and develop your product while you’re operating within a cashflow-breakeven manner. This takes the immediate pressure off of moving too fast and puts the focus on iterating to get your offering right. Plus, paying customers provide validation and leverage to potential investors.

Make sure you’re building your business on a solid foundation with a business model that scales.

In the early stages of business growth, it’s also important to ensure one customer isn’t dominating your revenue stream, so that you aren’t held hostage to one company’s specific feature set. The reality is, it’s dangerous to build an offering to fit the needs of one customer that may not always be around. Ideally, you’ve got lots of customers using the same core product and have distributed the revenue across them all.

Not all growth is good growth. Make sure you’re building your business on a solid foundation with a business model that scales. It’s important to eliminate as many false positives as possible and build out a strong foundation for your product and company to survive and thrive.

Get creative with credit

When you have paying customers, you can explore the various types of capital that may be available to you to help fund your business. You do not always have to forfeit equity to raise money.

For example, if you have a SaaS-based model that enjoys a predictable recurring monthly revenue stream, you may elect to take a credit facility that draws against the monthly recurring revenue.  This is a great option to explore as it’s a credit facility and keeps your options open versus a dilutive equity raise that adds more complexity to the business (increased governance, adding new directors to the board, etc.).

The necessity to execute and prove actual traction in the market enables options.

Keeping your funding options open can only happen if you’ve got a product/market fit and are showing adoption. Deciding whether to ask customers to pay for the service now is a necessary next step.

Every day we hear about the companies that have raised millions of dollars to fund their growth initiatives. Many of them will burn through those millions learning what it takes to get users to love their product. Many will fail. Not only is it such a waste, but what’s not talked about is that it creates a culture that most of the time won’t scale — it burns in and institutionalizes the wrong processes and thinking, which then makes it very hard to correct once profitability becomes a priority. And, you’ve added a lot more complexity to running your business, all while you figure out if your product really has legs.

And versus or

I love the idea of the genius of the “and” versus the tyranny of the “or.” What the and mentality provides is the need to create room for both “constraints” (revenue and profit, as an example) versus solving for only one. Clearly by doing this, it is much more challenging in the short run, but worth the discipline it takes to be able to solve for both to make the mid to long run really interesting.

Companies I’ve led have been in the fortunate position to secure funding — both debt and equity raises. The necessity to execute and prove actual traction in the market enables options. Fueling that tank with funding might be a great option to accelerate what you’ve proven out, but it can be a challenge while you’re trying to build and better your business.

Earning the right to take on more expenses enabled by actual revenue earned creates great discipline and keeps you grounded. A significant benefit as a result of this approach is that you don’t get too far out in front of your unproven assumptions, all while you keep more control of your company for as long as it makes sense. This is a significant advantage and puts you in a position where you have the leverage — the ability to have options.

Featured Image: William Andrew/Getty Images