daily articles for founders

Investment increases your risk

It's no secret that I'm a fan of bootstrapping. I like to retain 100% founder control of a business that I'm in. There are some circumstances where I'd consider raising capital (as a springboard, not a cushion), for the right kind of business, but I think they apply only to a very small subset of businesses that are interesting (aka fun to run) or likely, and to a vanishingly small subset of businesses by first-time founders.

That said, I do regard both methods - bootstrapped and funded - as valid ways to build a business. It all depends on your objectives and your circumstances. You couldn't start Google without funding, nor could you grow it to be the success it was. Facebook needed to own the social networking space before it could generate money, so it needed funding too. Even Apple, the cash cow par excellence, needed funding to help jumpstart its manufacturing operations (though nowadays, they'd probably have used Kickstarter). Some businesses are just capital-intensive. Some have a winner-takes-all kind of market where you must be funded to win. Some just don't have an obvious business model upfront.

Every once a while, though, I speak to someone about funding, in the context of a business that should be cash-generating fairly early, or is already generating decent amounts of cash, and they mention that they're looking for funding to decrease their risk. That's a terrible misconception. Funding does not decrease your personal or your business risk - it increases both.

Risk profile

Taking funding makes your distribution of possible results more binary. By default, a business can be anything from a complete failure (0% or even negative ROI) to a roaring success, with all the options in between available. If you raise funding, however, it cuts out a number of the middle options. VCs will definitely want an exit, and if the exit is too low, this can turn a fairly decent success into a relative failure for the entrepreneur.

For example, building a business worth £20m is a pretty amazing achievement, but if you've raised £10m from a VC to get there, with 2x preferential rights you would be wiped out and result in very little money for you as a founder. In that scenario, not taking the funding and building a, say, £5m business instead, would have been a far better financial outcome for the founder.

Angels can be a bit more forgiving, but they're typically looking to exit too, and taking that first bit of funding will gently push you down the road towards taking more and more. Angel funding does not necessarily make the outcome entirely binary (angels are more forgiving if you decide to just run your business and pay dividends), but it can still make a great first business success seem like a failure.

Remember, the VCs, despite all the rosy-coloured articles out there, are not in business to help you. They're in business to make money for themselves and their limited partners. Some do so in more ethical and helpful ways than others, and that's to be commended, but the fundamental business model of the VC is to get a good return on a few superstar investment and limit the damage as much as possible on all the other "failures".

No pain no gain

If funding makes things so much more risky, why bother at all?

Funding is worth taking when you want to trade additional risk for potentially larger gains. Talking of the "startup lottery" is not so far off the mark. Investment is a bit like gambling. When you raise funds, you take on a larger risk, both personally and on behalf of the company, in exchange for a potentially larger return.

If there was any way to increase return without increasing risk, everyone would have done it already (and in fact there are many ways, like getting mentors, learning about the topic, etc).

With this perspective, it becomes obvious when funding is a good idea: you should only take additional risk when you can afford it.

Most first-time founders are broke. Not only that, but being first-time founders, they are already carrying enormous amounts of risk, because they don't know how to run any kind of business, let alone a mega-successful high-growth tech startup. This is as compared with, for example, someone who has run and profitably exited a couple of more traditional businesses in the past, and is now looking for a new challenge. That experienced entrepreneur may be willing to trade some additional risk for a chance of a much larger impact than her previous ventures.

Given these circumstances, I would argue that new founders should be looking to decrease their risk, not increase it. As a first-time founder, it is better to have a risk curve that gives you a 30%-ish chance of making a fair bit more money than you were making in your previous job, with a fairly smooth distribution of lower outcomes and little chance of zero return (not that unlikely in my opinion), than a risk curve that gives you a large chance of zero return and a slightly higher chance of a very large outcome.

And therefore, first-time founders should almost never take funding.

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