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What are some of the disadvantages to taking venture capital?

Small Business, Small Business Financing
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May 2018

Finding affordable financing for a start-up can be a challenge for small business owners. Banks are wary of loaning money to a business without a two-year track record, and raising funds from friends and family has an inherent limit. A venture capitalist, however, can provide a company with the capital necessary for start-up costs and other expenses associated with expansion projects. An individual or firm acting as a venture capitalist has the funds for investing in a new business and the financing acumen readily available to help companies in their infancy, but disadvantages run rampant. Although venture capital is a viable source of equity financing, business owners should be aware of the caveats that exist with this type of funding.

Forced Management Changes

One of the most common practices in venture capital equity financing is the generally unwanted additional management personnel infused into the company requesting funding assistance. Because a venture capitalist typically has a great deal of business prowess, there may be an assumption a member of his or her management team is needed on the ground at the financed company. This can be presented under the facade of needed support and industry experience, but usually a business owner does not want or need an additional person in management. For the majority of venture capital agreements, however, these management additions are a requirement to receiving funding.

Loss of Equity Stake

Venture capitalists are able to provide small and start-up businesses with much-needed capital because they have easy access to it. With such large sums of money exchanging hands, it is no surprise equity positions within companies that accept venture capital investing are drastically shifted. A venture capitalist requires a large equity stake in the company to which he or she is providing funding to safeguard his or her initial investment.

Decision-making Ability

In addition to changes in management teams and equity stakes, receiving equity financing from a venture capitalist comes with more strings attached to the decision-making process. Business owners are typically required to consult with the venture capitalist individual or firm prior to making any decisions in capital spending, expansion and personnel changes. This can create tension between the business owner and the venture capitalist, as the funding person is most likely not working closely with the owner on day-to-day business operations.

Delays in Funding

Because venture capital investing involves a large amount of capital exchange, a venture capitalist may not be willing to extend all requested funding at the same time. This means business owners may have certain milestones to reach prior to receiving the financing they initially requested, which could put additional undue pressure on them. Delays in funding could also come by way of an extended vetting process of the start-up business asking for financing.

Although venture capital can be a viable means to obtaining necessary capital for start up or expansion, business owners need to be aware that venture capitalists assume a great deal of control within the business to protect their investments.

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