Why true entrepreneurs should avoid venture funds
Three years ago, I decided to attract investments for one of my projects — VoIP-messenger CallsFreeCalls. Before that I founded and developed, at my own expense, about 12 companies, and at a certain point I decided to find out how the venture capital market works, as well as trying to determine the value of fundraising. I instructed my team how to search for investors, and went to Silicon Valley for six months to see how it works in the USA. During the search for investors, and after closing a venture deal, I learned a few lessons about how this market is arranged and why true entrepreneurs should avoid venture funds.
Fundraising and business are not equivalent
In the process of communicating with investors I realized that fundraising is a real, full-time job which demanded my attention from morning till evening, and thus business management fell by the wayside. I asked a huge number of investors the same question — how can I do business and develop the company if I need to spend all my time attracting investments? Of course, the investors didn’t want to know — it was my problem, not theirs. At the same time, it’s not possible to hire a co-founder for the fundraising — venture funds only want to communicate with the project founder.
Many startups are becoming hostage to this type of situation; instead of growing, they are forced to find ways of raising money so that the business can survive for at least a year, trying different models and making pivots, and then moving on to the next investor. I know many startups that have successfully attracted funds — they have the whole machine running on fundraising, but the fact is that their founders are not entrepreneurs, they are just raising rounds.
Another part of the problem is that funds-managing partners are spending most of their time searching for startups, which leaves very little opportunity for improving their business skills. Often, the lack of experience prevents them from recognizing good projects from amongst dozens of bad ones.
Take a risk on yourself
Terms of investing is another interesting topic for conversation. Imagine the situation — the investor comes to me and says: “Let us invest in your startup with a valuation of $5 million, but before that you have to make $100 000 income a month”. Over the next six months I do everything to reach these numbers and after all this effort, the investor suggests investing on exactly the same terms with which we started! I do not agree — my company already costs a hundred times more. The investor did not want to share the risks with me and is now trying to invest on the same terms put forward a few months ago when the financial position was much less certain. I took the risk without his participation, and I do not want to help someone make huge gains from my hard work.
Now let’s consider the following story: I am building a company, putting years of my life into its development, and with each round of investment I am decreasing my shares. Investors are trying to persuade startups that owning 15% of the company’s shares, worth $100 million, is better than owning nothing. As a businessman, I will never agree to such terms, but a person who is engaged in fundraising will agree to anything. He will give the investor 70% or even 90% of his company, just to survive for one more year.
Of course, there are markets, like e-commerce, where at some point you simply cannot survive without investment. In the B2C business, however, you can create a product which is worth hundreds of millions of dollars with relatively small investments and without venture capital investments.
A successful startup pays for twenty failures
The CEO of a Ukrainian startup which recently received a large tranche of investment complained to me that he has to agree with all the terms of the venture capital investors. On my estimation, the founder of this project now owns no more than 15–20% of company shares.
There are a lot of such cases. In Silicon Valley, there is a huge resale market, where some funds help others to close their failures, re-selling the companies’ shares to re-distribute them. It would appear that the main aim of VCs is to cover all their losses through the gains of one successful company.
Instead of looking for a true entrepreneur that can build a successful business, they are looking for someone who is willing to pay for someone else’s losses. The fund invests in 20–30 companies, then one of them takes off and this money goes to a new fund and the story continues. It looks like a pyramid, and the funny thing is that it works. This is the fundamental contradiction — the venture market is created out of the desire to catch a non-business person who has built a business, but who does not fully understand the potential of what they have created.
Out of the vicious circle
Someone should break this system and begin to communicate with the founders of startups as equals, as a business person with a business person, sharing all the risks. For this experiment to be successful, investors of VC funds would most likely need to give their money to the fund, working on a new model. As a result, a new mega-fund would appear on the market and all other VCs would go the same way. If they could, of course.
P.S. We received investment on suitable conditions — in 2014 Altair Capital invested in CallsFreeCalls. Now we continue to develop, whilst simultaneously looking for projects where we can invest free money. We have more than ten years of experience in international business and we are willing to share our knowledge, experience and money with people who want to build a successful company, and progress far beyond startup level.