With reality television, people learn how to raise money to start a new business. These shows make it sound so easy; everyone is excited about a launch and thinks their company has something great to sell. But is growing a business with venture capital worth it?
The Small Business Administration reports overall, 85% of new businesses founded in the United States fail before their fifth anniversary. Per the National Venture Capital Association, 30% of venture capital-backed small businesses fail. With these statistics, new owners should ask themselves, will their company succeed with outside money?
New owners get excited about launching, growing, and making money. Very few have previous business experience and thus search anywhere and everywhere for mentors. In Netflix’s series named Halston, we learned how successful business owners can still lose it all. His original investor, Norton Simon, was acquired by Esmark in a leveraged buy-out. Halston’s design methods conflicted with the goals of his new owners.
Securing venture capital to launch and grow a business has many advantages. Firstly, it gets the company quickly off the ground. It may be easier than getting a loan and possibly missing monthly payments. Secondly, it helps move startups into new markets, providing publicity and exposure. And owners without prior business knowledge gain leadership, experience, and mentoring.
The list of disadvantages of acquiring venture capital is equally as long. As it happened to Halston, owners may lose control of their business altogether or forfeit an extensive percentage of equity. Investors will expect the company to grow within a reasonable time frame to recoup their money. Founders may give away more value than the cost of launching a startup with an interest-bearing loan. Venture capital funds are scaled and released based on company performance. If the business does not reach certain levels of growth, there is no future money. Investor contracts may include restrictions on the owners’ plans for the future.
Small business owners need to think about other challenges using investment money. How much equity is the owner willing to forfeit? Depending on the size of the investment, a venture capitalist may want 40% or more ownership. Even if new owners with no business experience have a great product to sell, they may still not have any room for leverage. They either take the deal offered to them or move on to search for another investor or source of funding.
What can small business owners do to protect themselves when signing an investor contract? Hiring an attorney experienced with venture capital agreements is an excellent first start. They need to explain the long-term possibilities of all the decisions surrounding the deal.
Getting to know the people personally behind the investment will help the owners decide if there is a personality conflict. When interviewing investors, ask about their long-term goals and how often they may have lost money lending to other new businesses in the past. What is the potential future value of the portion of the business the owner is giving away? If the person launching a new business doesn’t know how to value a company, ask an investment banker to help explain the parameters. If there is one principal investor, what happens to the business if he has a life-threatening event? Will they include details within the contract that allow them to resell their shares? Just like knowing a person before getting into a marriage, a small business owner should learn as much as possible about the people lending them money.
When the new owners showed up at his door, Halston learned he lost control of his company. Although he had many demons affecting his personal life, Halston’s major nightmare came back to haunt him. When he originally contracted with Norman Simon, he did not consider the long-term effect of the agreement. When he parted ways with his new owners, Esmark, he learned that by bartering his name in the original deal, he could no longer sell designs using the name Halston.
Business owners must focus on both the upsides and downsides of getting an investor. The more informed they are, the better their chance of long-term success.
Prominent entrepreneur, author, and business consultant Darlene Ziebell advises others on navigating the world of business. Her books, webinars, and workshops are based on methods learned from her own companies and hundreds of consulting clients. You can connect with Darlene on her website: DarleneZiebell.com