The standard definition of venture capitalism (VC) is that form of private equity financial capital invested in an innovative enterprise at an early stage of its development in which both the potential for profit and the risk of loss are considerable.
The standard path that venture capital investment follows is putting money into a company believed to have a high potential for growth. In recent years, venture capital investors have focused on businesses which have a novel technology or business model in high-tech industries, such as biotechnology, IT, and software. The typical venture capital investment occurs after the seed funding round as the first round of institutional capital to fund growth.
The objective of the investing company is to to generate a return through an eventual realization event, such as an IPO or trade sale of the company.
On the surface, venture capital is an attractive option for new companies with limited operating history which are too small to raise capital in the public markets and have not reached the point where they are able to secure a bank loan or complete a debt offering. It is one of the few alternatives to what is known as “angel investing” and other similar seed funding options.
One of the the advantages that venture capitalists promote is that, apart from the financial capital, they can also provide valuable expertise, advice, and industry connections. In addition, repayment of VC investors isn’t necessarily an obligation in the same way as a bank loan. Rather, investors are shouldering the investment risk because they believe in the company’s future success.
So, what’s the downside of VC investment?
The main disadvantage of this form of investment is loss of control. In exchange for the high risk they assume by investing in smaller and less mature companies, venture capitalists usually get significant control over company decisions, in addition to a significant portion of the company’s ownership and consequent value. A stipulation of many VC deals includes appointing a venture capitalist as a member of the company’s board. This way, the VC firm has intimate involvement in the direction of the company.
Most VC deals also come with stipulations and restrictions on the composition of the start-up’s management team, employee salary, and such like. Furthermore, with the VC firm literally invested in the company’s success, all business operations will be under constant scrutiny. Conflicts arise because the very entrepreneurial nature of the founders of these types of companies does not usually fit comfortably in such a structured and controlled framework.
Is there a viable alternative to such a scenario?
We spoke to a man named Peter Reinert who says says that there is another way. He operates a number of companies which raise funds, but with a focus and emphasis on the business itself. His group specializes in structuring and negotiating complex business transactions, including mergers and acquisitions, leveraged buyouts, recapitalization, growth capital investments, debt and equity financings, and securities offerings with a focus on partnership with the entrepreneur rather than taking over the business or asking for a substantial part of ownership.
Wall Street Journal tech writer Christopher Mims wrote that venture capitalists, and consequently the start-ups they fund, think it’s better for their purposes to advertise today rather than to innovate tomorrow. VC culture has made the numbers more important than the tech
“Every smart CEO and CTO I’ve known has viewed VC money as a deal with the devil: In exchange for the money, you commit to constant interference and endless pressure to deliver the goods earlier rather than better. You should only take the money after you’re strong enough to hold your ground—or, more often, when you have no other choice.”
Peter Reinert is in full agreement.
“Venture capitalism can seem like the silver bullet for a cash-strapped start-up or an entrepreneur with an idea, however, it isn’t as cut-and-dried as it seems. In my opinion VC is sometimes portrayed as a ‘money for nothing’ enterprise that lets someone with an idea run wild, but the reality is, once a company hitches itself to a VC, they often lose a great deal of control over their own growth.
“Goals get shifted, deadlines and focuses get moved to things more in line with the investor’s idea, regardless of what’s best for the customer or the company. It’s a source of money, sure, but it can hinder creativity. It all comes with a price. In our fund-raising world we control the application of the funds we provide, not the control of the company, innovation, deadlines, goals or direction. Done correctly, everyone wins.”
Peter Reinert is also scathing about what he considers the lack of the creative spirit of most venture capitalists.
“When I go to a VC conference or office or event I feel like I’ve stepped back into 1969. They are so extremely sheltered from the current business population and creative class that they don’t realize their own isolation. The model is old and antiquated and stifles innovation in many cases,” he said.
It is important that entrepreneurs be made aware that there is another way to finance their new ventures, apart from traditional venture capitalism.
Someone like Peter Reinert could be their best option.