Every start-up dreams of that million or billion dollar valuation, however they rarely stop to question its real cost. In a recent study by Forbes Magazine, 90% of all startups fail, including those receiving the coveted valuation, proving that what we should be asking is - what does equity funding really do? or, more on the nose - why do so many start-ups fail?
To understand this, it’s important to first understand the rationale behind the VC's investment process. Like all savvy investors, a VC diversifies its investments in order to protect its losses. However, since they only invest in tech start-ups, their thought process is a bit different - they will invest in 10 start-ups with the knowledge that at least 8 will fail, because all they need is 1 start-up to complete an exit or IPO and their equity stake typically covers their failed investments.
This being said, if you are the CEO of this 1 start-up, you may end up owning less than 10% of your company, which means not only do you forgo a huge pay day, you also have no control on the direction of the company. So after all the hard work and sleepless nights what do you gain? A few hundred thousand dollars and no company? Is it really worth it?
These days with the amount of start-ups looking for funding, VC's have the upper hand and can take 20-40% of a company in the seed round alone. Moreover, they decide a company's worth - that valuation could be lower than desired, giving the VC a chance to reap better rewards when the company makes it big.
This seems disheartening but there is another way.
How can a start-up raise money and still keep all its equity? The answer is debt financing. That's right - debt isn't always a bad word. There are numerous government backed loans available to start-ups, as well as regular debt financing through a fund or a bank. With these options, the government will cover 60-80% of loans through its participating vendors, which mitigates risk. This route also allows a start-up to grow organically, keep all its equity and, if there is still a need for equity financing, the flexibility to enter negotiations with VC’s with more negotiating power.
Let's grab coffee and we can talk all about the best path for your company.