When you think "funding for entrepreneurs," Venture Capital is probably what you think of. VC firms can have millions upon millions of dollars at their disposal, with the express goal of investing in early-stage startups. Of course, these Fund Managers don't do so out of the good of their hearts—they expect a return. On this page, we're going to talk about how valuation works, some common misconceptions about venture capital, and whether venture capital is the right route for you and your startup.
The basic premise of most funding, but especially of Venture Capital funding, is that firms buy a percentage of your company in exchange for their cash. That means that their purchase carries with it an implicit assertion of what your venture is worth at that moment (e.g. if somebody offers to buy 50% of your company for 1 million dollars, that means the post-money valuation of your venture is 2 million dollars$^1$.)
<aside> 🤑 Pre-money and post-money just refer to the value of the company before and after the capital is acquired. Pre-money + funding = post-money.
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Obviously, if somebody has purchased 50% of your company, that means you only have the other half remaining to be divided among your team, or sold to other investors. The process of your ownership share growing smaller and smaller as more investors buy in is known as dilution and it's one of the big reasons you might think about alternative sources of funding.
"A startup needs VC to be successful"
Hopefully the Funding page has already dissuaded you of this, but there's lots of ways to fund a venture besides VC.
"A higher valuation is better."
It feels nice, obviously, to be told by a VC firm that your company is worth a lot of money, especially when part of telling you that is also giving you a lot of money to work with. But larger valuations may include terms that end up being more restrictive$^2$, require sacrificing more ownership, or give those VCs a much larger slice of the company if/when things don't go as well.
"You can only get VC money in places like Silicon Valley or New York"
This is a bit of a half-truth, in that there is a lot more VC money to be had in places with a lot of startup activity taking place. A pitch that fetches $3 million in the Valley may well get you half a million or less in a smaller city like Richmond or Atlanta. It's not that the idea isn't just as good in those places, it's just a problem of supply$^3$.
"If a fund invests in you, it's really important to them that you succeed"
This isn't exactly a myth, but it's a bit of an oversimplification, because Venture Capital firms have portfolios ****full of startups, and they expect the majority of them to fail. (Yes, the majority. Like 9 out of 10.) They don't particularly care whether you are the one, or in the nine. They're diversified in a way that you aren't, and have different goals for your company. It's important to keep that in mind.
So what are a VC's goals? Two words: massive growth. Because so few VC-backed ventures are going to succeed, the few that do need to be huge winners. So the questions you need to ask yourself before accepting VC money are:
The second question is the critical one, because many founders will fall for the allure of big checks without considering whether they could get by without them. And when you can get by without them, you've got more time and more control to make your business work for you rather than making it work for big investors.
I understand this page has come across as maybe a little bit anti-Venture Capital, but that's not the intention. It's just important to have a balanced, nuanced view of your funding options. Don't worry, there are more coming.