Here's why startups should think twice before turning to venture capital

So you’re ready to kickstart your business. You have your idea. You have corralled a few people to do the groundwork. Now, you just need a way to fund it, which is easier said than done. With so many options – think bank loans, credit cards, crowdfunding and raising capital – the process of choosing the right funding model can be incredibly complex but one that can ultimately hold the key to the long term success of your business.

In recent years, we’ve seen many businesses go down the venture capital road. Canva, Atlassian, Campaign Monitor are all big Aussie brands that have relied on venture capital to kickstart or grow the company and are now smashing it internationally. And with all these success stories, it’s easy to forget that like many external funding options, there are certain trade-offs.

With venture capital for example, once you enter into the agreement, the venture capitalists hold equity in your company meaning you’re unlikely to be 100% in control. There’s a very real chance you could lose corporate autonomy, the ability to control your own vision for the company and you might end up finding someone who funds you that simply isn’t the right fit for your business or your team. So you need to consider if this is something you could (or should) accept.

There are many misconceptions around funding and why people choose this route. Some founders use the funding to fulfil their burn rate — their monthly expenses minus any revenue — but this can provide false stability for an idea that doesn’t have the right market fit or the right team. Others fall into the trap of thinking funding equals money which equals runway, which means you have more time to work on a product.

But this can also lead to focusing on relatively unimportant issues and not properly building a minimum viable product (MVP). Companies should be building products based on solid research and work, releasing them as early as possible, finding market fit and getting feedback to gauge profitability. But this sometime falls on the wayside when relying on venture capital funding.

Unfortunately, the truth of the matter is that most people raise funds to raise users when they probably don’t have a value proposition or a revenue stream. This is the “flipping fallacy” that they’ll “growth hack” their way to a user-base someone else will buy off them, but this is not a sustainable or even strategic business plan for an offering. Instead, it just leads to money being blown away on ideas that actually return no value other than having a large user-base which may or may not be engaged and loyal users.

What every entrepreneur needs to remember is that at the core of every offering is a solid value proposition or good idea. A good idea should do one thing and do it well. It should solve one substantive problem — a small solution can do this and will also allow you to focus.

From my experience, the best way to get off the ground is to bootstrap your company. Work on your idea in your spare time while you’re already getting paid and try to line up some initial customers. Ideally, you’d get people to pay money down before a single line of code was written for a potential future product, cultivate that kind of market fit and work to find people your product fits.

Consulting is another great model that companies like GitHub and Basecamp have gone through. Consult on other offerings and use the income from that to cross-subsidise product creation so you can bring your true passion products to life.

Keep in mind this model is most suited to businesses in the software space because of the lack of capital needed to scale up sales and build out product. But anything intangible or in the intellectual property space is a great option to spin up and work on bootstrapping to build your own company.

There are clearly pros and cons to any funding model you choose. It’s just a matter of understanding what trade-offs you can live with, and what are non-negotiable. Once you have a better idea of this, then the decision will become a lot easier. But one thing for sure is that you shouldn’t just jump on the venture capital bandwagon because everyone else appears to be doing so. You need to make sure you have a funding model that will set you up for success now and in the future.

Seb Pedavoli is the co-founder and creative director at Aussie software company, Proxima.

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