Mo’ Money, Mo’ Problems

 By Travis Townsend

You have a great product and fantastic services. In fact, you have blown away every person to whom you have shown your business plan. The team you have put together is exceptional. The materials needed to build your product are inexpensive, and there are no competitors in the market. All you need now is capital to pay for manufacturing, marketing and distribution. Venture capitalists to the rescue, right? Not so fast.

Almost every single principal of an emerging company believes that increased capital will solve the great majority of their problems. They desire to get an audience with a venture capital firm or some angel investor to wow them with a presentation of their amazing business model. Hopefully, the result will be a large investment in their company so they can implement all their strategic plans and achieve projected profits. Newsflash – venture capitalist investments come with strings attached and added responsibilities.

Venture firms do not make investments in ANY company lightly. Yes, they have tons of capital to spread around, but that is for the single purpose of making those funds grow. Good fund managers are not gamblers and the great ones limit their risk as much as possible by thoroughly vetting the businesses in which they invest, establishing tremendous hedges against loss and exerting considerable control over the management of such businesses. In the event you seek capital from a VC, be prepared to answer to a new boss and embrace additional administrative.

The terms of venture capital transactions are fairly standard, so you can always expect the VC to want the following at a minimum when you receive its money: preferred stock with dividend and liquidation preferences; the right to convert the preferred stock into common stock; protection against having its equity position diluted by additional issuances of equity; representation on your company’s Board of Directors; rights to see certain information about the company from time to time and upon request; and the right to register its shares if you register any of the company’s stock for public sale. Moreover, depending on your company’s particular situation, the VC may want very oppressive terms in exchange for the capital you hope to obtain from it. You must consider carefully exactly what you are getting into when you take cash from a VC.

In order to protect yourself, your company and your dreams, understand your leverage before sitting down at the table with a VC. Know that if you need cash to make payroll and pay rent at your headquarters tomorrow, the VC is going to take you for a ride. Such a ride can be painful, but faced with going down with the ship in your capacity as captain or turning over the wheel to a VC, you just might be better off becoming a second mate on the boat you built.

If possible, be discriminating in who you accept monies from. Not all VC’s are created equal. Some funding sources are more flexible than others. Some are more hands-off than others. Rest assured the VC will conduct its diligence on you and your company; you should do the same. A capital injection may be the end of many of your problems, but it can be the start of a whole new set if you are not careful. If you need the money, by all means go after it. Just understand venture financing is not the end game; it is only the beginning.

 

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