Excessive Seed Capital Can be a Burden for a Startup Company
Excessive seed capital can be almost as bad as none for a startup company. There are a number of reasons for this, some general and others specific. Let's start with some general common-sense arguments against too much startup funding first.
Sure, it sounds great if you are looking for $1 million dollars in funding and are offered $10 million. Many young and inexperienced entrepreneurs will jump at it. However, before you accept such offers keep in mind that this type of capital is not offered free, and if you get more than you want you might also be giving away more than you want. Here are some reasons why excessive venture capital seed funding might not be all it seems.
1. Too Much Cash Can Breed Laziness
Ok – you have worked your guts out to get your firm started, and employed the absolute minimum of staff – if any at all. Suddenly you find your new company awash with cash. Will you still work till you drop, or will you start going home to have dinner with your family. Maybe you will take in that ball game you would have missed without all this money to pay the bills?
Yep – you might tend to get lazy. If you accept just enough angel or VC cash to solve a difficult problem, such as pay for that software you badly want, employ that lab tech you badly need or help open a new office nearer your customers, then that's OK. But don't forget who got you here - you! You and your hard work, and if you lose that valuable asset then guess what! You are on the way down! You will use up the cash and find you have very little for it.
2. Slowing Down of Development
Allied to the issue above, if you have excessive seed capital you feel you have more time before your cash runs out. Silicon Valley call this the 'runway' – the shorter the runway the more urgent it is to get in profit. The longer the runway the more time you have.
Fred Wilson, founder of New York VC company Union Square Ventures, says that the amount of money an entrepreneur raises for seed capital is inversely related to their success. In other word, the less seed funding you accept, the more likely you are to succeed because you will work your socks off to make money before your funds run out.
3. Investor Pressures
A London UK company, PeoplePerHour, was started up by Xenios Thrasyvoulou as a freelance online jobs exchange. Around a year after starting up the company, he negotiated £500,000 (~$800,000) angel funding, which in turn interested a few venture capitalists. Ultimately he found himself with $10.5 million dollars in investments. The result, in his words, was "total chaos."
Within a year his employee count multiplied by ten to 50. He found himself with a board of directories with six-figure salaries and was faced with an investor demand to generate a year on year gross income increase of 600%. Luckily he had the sense to retain a majority share, so forced his investors to accede to changes which involved an employee reduction of 50% and most of his top managers also had to go.
He now doubles his revenue each year with a 20% profit margin. Never accept so much funding that your investors own the company between them. You may quickly find your own plans for the future are irrelevant and that you are in effect working for your investors. More on this later.
4. Insufficient Time to Identify Potential Issues
Uber is new company that enables you to get a cab using a cell phone app. You use the app, order the car and Uber sends a private car that is available. They are not registered cabs, but private people with a car who have been vetted by Uber who phone them at home when needed.
Just 5 years after being founded, Uber received $1.2 billion funding. It is now valued at $18.2 billion – but there is a problem on the horizon. Regular taxicabs are fighting back and question the legality of Uber. Its service was banned in Brussels and across Germany, then the ban lifted in Germany. It was then re-banned in Hamburg and Berlin. The same issue is now looming in the UK.
The problem appears to be one of safety, in addition to the service not having to be registered as regular taxi drivers must legally be. It is important to consider everything that could possibly go wrong when accepting large amounts of venture capital – and does Uber's business model warrant this scale of investment? No doubt Uber will overcome this – but what if. . .
Groupon is another example. It went public in 2012 with a valuation of $12.6 billion, and a high share price of $20. A year later it was down to $5. This was because of two main reasons: other firms copying its business model and an unpredictable use of its service.
5. Retaining Too Small a Stake
One danger of getting too much seed capital is that you may retain too small a stake in your own company. Once you go under 50% you may be in trouble, because you are no longer guaranteed to control the decisions. If Xenios Thrasyvoulou had not retained a majority stake in PeoplePerHour, he may well have failed with it. Future investment in a new company would have been very difficult to get.
Venture capital funding does not come free, and even angel investments come at a price. Usually that is a stake in your company, and the more you get the bigger the stake. The same is true of individual investors: the more VCs you accept cash from the more of a stake you are losing in your own firm. Make sure that the time does not come when a VC knows better than you and overrules you in the boardroom.