Raising Capital

Independence and investor seduction

Entrepreneurs are often in a mental fog when considering investors. Business angels, venture capitalists and acquisitive companies can be seductive. A charismatic outsider may counsel, “it’s better to own a small piece of a big pie than a big piece of a small pie.” He says he can help with introductions, a high-end rolodex and a strategic-fit. The entrepreneur is courted. The potential cachet is enormous.

For entrepreneurs driven by independence, there are three reasons to pause.

First, “owning a small piece of a big pie” cannot be quantified upfront. 100% of a $500,000 profit is numerically identical to 1% of a $50 million EBITDA. However, will $50 million be realised and dilution exceed 1%? Venture capital firms might promise a rolodex of potential contacts, but entrepreneurs should ask if their own networking nous could open similar doors.

Second, the loss of control is real and majority ownership no protection against it. The fine print within every shareholder's agreement I know requires the entrepreneur to consult, from capital expenditure to admittance of new shareholders, from mandatory dividends to debt arrangements. Further still, investors will inevitably exercise control over the entrepreneur’s remuneration and, ultimately, the entrepreneur's CEO role. As former venture capitalist, Simon Acland, wrote in Angels, Dragons & Vultures (2011, Nicholas Brealey Publishing, ISBN 978-1-85788-551-4), "During my venture capital career, I sat on the board of 23 companies. In only 7 cases - less than one third - was the chief executive I originally backed still in that position at the end."

Third, once control is lost, it is expensive to reverse the decision. Professional investors just do not sell at less than their entry price. They must have their return and, frequently, it is the entrepreneur who pays.

On one side of this decision-scale are the likely gains in owning a smaller share of a larger enterprise and the real value of an investor’s network. On the other side is whether the entrepreneur can stomach the irreversible loss of control. Weigh these carefully.

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