Even the most successful VCs will only see one in 10 investments work, says entrepreneur Andrew Michael. Photograph: blickwinkel/Alamy
It’s seen as the holy grail for many small businesses. But could VC investment do your company more harm than good?
Entrepreneur James Davis* secured £100,000 in venture capital finance to start an IT business, in exchange for a 50% stake in his company. He was assigned a “handler” to talk to, but says there was “very little engagement or involvement” and “none of the dialogue” he expected.
“Nine months later we were growing but not at the rate required by the VC, so I went to a meeting with the handler to discuss next steps,” he says. “After an hour looking at spreadsheets he said it was time to wind the business up. I assumed I’d have a month to implement that but he said: ‘We’re going to do this right now’. I almost threw up in his office.
“I was immediately on the phone to customers closing projects, then I went home to tell my wife, and into the office the next morning to let our employees go. Within 24 hours, literally, the whole thing was over.”
Davis feels he started the company without adequate experience or support, and believes his backer had no real interest in the business. “That’s why VCs are very good at doing what they do; there’s no point burning a single pound more once you’ve made that decision [to close a business]. It makes sense not to delay things but at the time it felt very brutal,” he says.
“Securing venture capital is a top priority for many small businesses, but I don’t see it that way,” says Jean Salha, CEO of IT networks company Teneno, which is currently seeking £150,000, via the equity crowdfunding platform, Seedrs. Salha believes other small businesses should “stop chasing the VC dream, which very rarely works out for all parties” and instead consider alternative finance options.
“Small business owners tend to bend over backwards to please their backers, but end up sacrificing a lot of time pursuing VC funding, and failing,” he says. “In reality all that matters to venture capitalists is the bottom line. Most need to get their money back within a short timeframe, earning a 10-fold return on that investment.”
It’s a risk that entrepreneur Andrew Michael feels is often misaligned with the interests of those who start small businesses. Michael launched web hosting firm Fasthosts, which reported a turnover of £20m and a profit of £5m before its sale in 2006, and later founded cloud storage business Livedrive. He now runs bark.com with co-founder Kai Feller and has repeatedly shunned venture capital opportunities.
“I think these guys are often vultures dressed up as cool, caring, supportive, people,” he says. “Even the most successful VCs typically only see one in 10 investments work. Most people who start a small business have absolutely everything riding on its success, yet a VC wants it to make £100m a year with strategies that bet the whole company and might only offer a 20% chance of success.”
That’s not a risk Michael was prepared to take. “I’d rather be a cockroach [a robust, sustainable business] than a unicorn [one which reaches a $1bn valuation very quickly],” he says. “Building a business one step at a time might take longer but you have a higher chance of success, retain a bigger shareholding and stand to make more money.”
Finding the right VC
Matt Fox, CEO of holiday booking marketplace Snaptrip, believes the “vulture capital” moniker is misleading. Snaptrip has raised £2m+ of investment to date, including via VC firms Forward Partners and Bestport Capital. Fox says it’s important to distinguish between “top-tier super-aggressive growth funding” and other VC institutions that can be of benefit to small businesses in need of startup cash.
“If it weren’t for Forward Partners, Snaptrip wouldn’t exist. They allowed me to get it going and validated, and gave me a good grounding to go on and get further investment,” Fox says. “What’s disappointing about the VC ecosystem is that so many entrepreneurs want to shoot for the stars – chasing the ridiculous dream of top-tier VC backing – without understanding that there are other VC options for funding a small business.
“It’s too narrow-minded to say all VCs are vultures. They can be very controlling because they typically take serious presence on a company’s board and can integrate ‘nasty’ terms such as having their money covered in the event of a distressed sale but they have incredible investment mandates and very clever people making good companies, so they absolutely have their place,”he says. “If you look at it from their perspective they’re putting up all the risk … why shouldn’t a VC who offers you £3m want some kind of protection?”
Resisting venture capital is as much about retaining control as it is about risk-avoidance, says Philip Storey, founder and managing director of customer lifecycle marketing agency thisisenchant.com. He has been offered “all sorts of funding options”, including venture capital, but hasn’t been tempted.
“I would have felt like I was poisoning my own company by allowing external investors into an intimate consulting practice,” he says. “VC backing would have compromised our culture; something I am not willing to risk, ever.”
Storey admits that running a business which relies on its own cashflow to stay afloat can be “scary” compared to the “easy route” of VC backing, but urges SMEs to consider the hidden cost of venture capital investment.
“You’re potentially diluting the dream you had when you started out,” he says. “There are so many unicorns cropping up but many are land-grabs rather than investments, with VCs pretty much buying their way into businesses and kicking out the people that started them. Instead, we’ve grown organically and gracefully, and it’s happened on our terms.
“There’s a lot of talk in the startup world about the benefits of failure – fail hard, fail fast, that kind of idea – but I don’t really buy it,” Storey adds. “I think there is a lot to be said for just trying to get your idea right in the first place. That’s not easy with somebody leaning over your shoulder trying to get their money back. I just don’t think that is conducive to creating a great business.”
Davis has recently launched a new successful venture, which has reached the point where external funding could enable upscaling. “But at the back of my mind there is always that meeting where someone else was able to shut the business on a dime, and I couldn’t do a thing about it,” he says. “I don’t want to retain full control of an enterprise but I do want a say in whether or not it continues, and when – or if – we pull the plug.”
*James Davis’s name has been changed at the entrepreneur’s request