Do Startups Need Venture Capital?

Before we answer the question of whether startups need venture capital, let us start with the idea of running a startup first. After seeing and hearing about break-away success stories such as Uber, Strava, Zoom, Robinhood, etc., you might think that starting a new business activity might be an attractive proposition. You might even be a new startup with high hopes. But there are a few sobering facts one needs to consider first:

• 90% of startups just outright fail and die out.
• 20% of startups fail during the first two years of operation.
• 45% of startups fail during the first five years of operation.

What these facts tell us is that the startup space is much more failure-ridden than it meets the eye based on our intuition. This seems to be a cognitive bias.

One of the ways startups try to boost their chances of success is by gaining access to more capital. This is where Venture Capital (VC) firms come in. They are firms that specialize in investing into startups, and aim for their investments to become highly scaled third-party acquisitions or aim to win scaled profits by taking their investments public. This article looks at this specific situation from a startup’s perspective and argues what to consider when considering such an option. This would be highly relevant if you are running or planning to run a startup. This would still be relevant for other situations in life, as the factors outlined here draw parallels to daily life in general (addressed in later sections).

This essay is supported by Generatebg

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Is Access to More Capital A Good Thing?

Money is in almost all cases in life, a means to an end. Problems start arising when it becomes the end.

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Regardless of the motivation for acquiring more capital, it usually functions like a scale-factor. If a startup or a person has inherent conceptual or moral flaws, these flaws also usually get scaled-up. If the startup or person fails to address these flaws, things start going south faster than without the capital in the first place. To express bluntly, when a morally bad person gets a lot of money, it is prudent to assume that he or she is not suddenly going to become righteous. In the case of startups, premature scaling is cited as one of the primary reasons of failure. In other words, when a startup successfully achieves access to more capital without solving fundamental issues that are lurking, it is likely on a faster failure-bound journey.

Why Do Startups Need Venture Capital?

Here’s another interesting fact that is of relevance to our case:

• 75% of VC-backed startups fail.

While the failure rate is sadly still high, it appears that involving a VC reduces the original failure-rate by a whole 15% (down from 90%). This is in itself one of the strongest propositions of VCs. They bring with them, their expertise gained from working with startups on a day-to-day basis, and in doing so, increase the chances of success of a startup. Plus, they inject extra cash. That is indeed a worthy proposition to consider. So much so, that many startups aim to become VC-backed by XX-Date from the date of founding. One of the most prominent and innovative examples of such a VC firm would be Y Combinator.

The Catch?

Right, you guessed it! There’s a catch here. All that money from VC comes with *Conditions Apply. Don’t get me wrong; the VCs want their baby startups to succeed. But they want them to succeed in a particular way. This reminds of a math teacher who once said, “Your solution appears to be correct, but you did not follow the method I taught you. Therefore, you will not get any points from me.”

The VCs want their startups to grow exponentially, and eventually get flipped either to third-parties, or go public. Key words here are “exponential”, “flipped / sold / acquired “, and “go public / get listed”. If your startup’s progress metrics are not ticking any of these boxes, expect a lot of pressure from the high and mighty VCs. In other words, a startup that gets funded from VC is selling control of its leadership (partly) in exchange for the incoming funds.

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Even though your startup now has 15% increased chances of #success under a VC, if your definition of #success varies from the VC’s definition, you’re in for a painful ride. Furthermore, VCs don’t care about your values, feelings, or any other human emotion driven metrics. Their metrics are purely numbers in relation to their key words towards #success. They push the startup to niche down (in other words, take more risk), whereas in the background, they diversify in the number of niches they invest in by choosing startups from different niches. In other words, the typical VC-backed startup is carrying a massive amount of risk, whereas a typical VC holds a well-diversified portfolio of startups. With a 10-25% success ratio, VCs make a tremendous amount of profit. Have you ever wondered how insurance companies make profits? The mathematics behind both models is very similar.

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How Does This Relate To Day-to-Day Life?

You might be thinking, “Hang on a minute. This is useful information for startups that are considering VC-backing, but how does it tie-in with my day-to-day life?” Well, I assure you, it does. If you’re an employee who is looking for your next prospective employer, this very same dynamic comes into play. The VC gets switched out with your employer, and your startup gets switched with your #HappyLife.

Here are a few examples of other situations that feature a similar dynamic:

• You are a young college student in your 20s still living with your parents.
• You are a spouse who is financially dependent upon your significant other.
• You are an established business who values stock holders more than your customers.
• You are a random young girl whose definition of success stems (purchased) from social media.
• You are a random young boy whose definition of success stems (purchased) from motivational quotes (potentially on social media).
• You are Darth Vader (scratch this one out; it’s a bad joke).

Do Startups Need Venture Capital? – Conclusion

I’m not against VC- or backing of any sort, but one has to really value originality and authenticity before deciding to go for backing. All this article does is it tries to expose conflicts of interest between backed parties and backing parties. The party seeking backing should ideally thoroughly assess its situation, and should only choose to go for a backing if either a) the interests of both the backed and backing parties align or b) the backed party has a clear advantage out of the deal. The latter scenario would fit for companies like Amazon or Tesla looking for new locations for their new factories or warehouses. Local governments (backers) are literally competing on subsidies offered to these companies because of the employment opportunity these companies potentially create in these localities.

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