All forms of financing come with certain risks, and venture capital financing is no exception. It offers a convenient alternative to debt financing. You can obtain venture capital financing by selling an ownership stake in your business. Unlike debt financing, you won’t incur new debt from it. There are certain risks of venture capital financing, however, of which you should be aware.
Understanding the Risks of Venture Capital Financing for Entrepreneurs
Venture capital financing involves a valuation. When you seek an investment from a venture capitalist, he or she will value your business. If you have a compelling business plan, the venture capitalist may give your business a high valuation. A poor or nonexistent business plan, on the other hand, may result in a low valuation. Regardless, venture capital financing comes with the risk of a low business valuation.
One of the biggest risks of venture capital financing is ownership dilution. You’ll own a smaller piece of your business with venture capital financing. This is because venture capital financing involves the sale of ownership. It’s not classified as debt financing. Rather, venture capital financing is a form of equity financing that, like other forms of equity financing, requires the sale of an ownership stake. You can use it to raise capital without taking on new debt, but venture capital will result in ownership dilution.
Another risk of venture capital financing is the dependency cycle. What is the dependency cycle exactly? This occurs when an entrepreneur’s business becomes “dependent” on venture capital financing. Most entrepreneurs use venture capital financing for startups and early stage businesses. Since these businesses aren’t profitable yet, they will often rely on venture capital financing. After burning through the initial round of financing, entrepreneurs may initiate a second or third round of venture capital financing. This can trigger a costly cycle in which entrepreneurs become dependent on venture capital financing to keep their businesses afloat.
Venture capitalists may require that the businesses in which they invest meet certain milestones. Failure to meet these milestones can trigger consequences, such as additional equity dilution or changes in leadership. If you’re thinking about using venture capital financing, you should consider these milestones and whether you can meet them on time.
This article was brought to you by Intrepid Private Capital Group, a Global Financial Services Company. For more information on startup and business funding, or to complete a funding application, please visit our website.