The pros and cons of venture capital equity financing

Jonah Remz
Jonah Remz
Head of Finance
Posted on
August 17, 2023
min read
The pros and cons of venture capital equity financing

Venture capital equity financing is one of the most well-known financing options for startups of all sizes, to the point that startup growth is often measured by what round of VC financing you’ve achieved

But venture capital isn’t the only option out there. In fact, despite its fame, very few startups ever use VC funding: Forbes reports that as little as 1% or less of all startups use VC funding at any point in their growth journey.

But of course, most startups also fail—so if you want to be successful or reach unicorn status, you should probably get VC funding….right?

Well, it depends. Most successful SaaS companies get VC funding, but it’s not necessarily a requirement, and it’s especially not necessary to secure a VC round every time you need financing. There are many alternatives out there that can help you get the money you need without diluting equity, and there are many downsides to venture capital that can make you wish you never received it.

Keep reading to learn the pros and cons of venture capital you should consider before starting the process of pitching to VC firms. 

What is venture capital equity financing?

Venture capital equity financing involves venture capitalists injecting funding into startups in exchange for ownership shares, called equity. A startup can use this capital to fund product development, market expansion, operational enhancements, and anything else required to grow the business. While angel investors and other types of investors may also use a similar equity investing model, venture capital specifically comes from venture capital firms. 

Venture capital funding rounds typically provide startups with $1M in funding or more, with some rounds going into the $100M’s. In exchange, the venture capitalist gets ownership over 15% to 20% of your company, with some even taking 50% or more. This ownership isn’t just a technicality—when you onboard a new VC, they will act as your company's partner and have a major say in your company’s direction, vision, and strategy. 

How does applying for venture capital equity financing work?

Getting venture capital equity financing requires a series of steps that take several months. Startups opting for this path undertake meticulous due diligence, negotiations, legal documentation, and regulatory approvals. This process culminates in receiving funding that varies based on the startup's growth potential and investor perception.

Pros of VC equity financing 

VC financing offers a range of advantages that make it an attractive choice for startups seeking capital infusion. Here are some of the key pros of VC equity. 

Access to substantial capital

One of the most significant benefits of VC equity financing is the amount of funding it gives you.

Unlike bootstrapping, crowdfunding, debt financing, or revenue-based financing that could usually get you a few million dollars at most, VC funding rounds can be in the 10s or 100s of millions of dollars. Because of this, securing your first VC equity round is often seen as a sign that your company has “made it” as a serious company.

VC investors do this because they’re keenly interested in high-growth potential companies and are willing to sink in a large amount of money if they believe your company has what it takes to give them a 10x or 100x return on investment (ROI). This capital can provide your company with what it needs to accelerate growth without worrying about running out of money. 

Opportunity for a strategic partnership

Venture capitalists bring more than just capital to the table—they also bring expertise and connections. Because of this, VC equity provides an excellent opportunity to forge a partnership with someone who could help you make intelligent business decisions.

Venture capitalists are often ex-entrepreneurs themselves who have become financially successful enough to pivot into investing. This means they may have decades of extensive industry knowledge, well-established networks, and proven experience in scaling businesses—and they use this expertise to help the companies they invest in. 

Partnering with a good venture capitalist who understands your vision offers you access to valuable insights, guidance, and connections that can prove instrumental in navigating the complex business landscape. They can help you build roadmaps to success, identify and avoid bad business opportunities, and even help you see new opportunities to expand. 

This expertise is particularly valuable for less experienced entrepreneurs who may be an expert on their products but need to learn more about the complexities of creating a business.

Shared risk

When you start a business as a sole founder with your life savings, a few credit cards, and personal loans, the risk is all on you—if you fail, you lose all your money, and it’s all your fault.

Venture capital changes this dynamic. The burden of potential losses is distributed through the equity ownership structure, with investors shouldering a proportionate share of the financial risk. This means there’s a bit of a safety net that insulates a founder’s personal finances from absorbing the full impact of adversities. If your business fails, you don’t owe your investors millions of dollars—they simply lose it as an equal owner who invested at their own risk.

This shared accountability also provides a psychological benefit. When you have a partner, you share the burden of ensuring your business heads in the right direction. A venture capitalist can help you make sound business decisions, but they also share the blame if these decisions don’t turn out well. Conversely, you get to celebrate as a team if they go well.

Both the tangible and psychological aspects of this relationship can help you stress less and free up your emotional bandwidth to deal with other problems, as the burden of the entire business doesn’t solely rest on your shoulders. 

Cons of VC equity financing

While VC equity offers lots of benefits, it also has several downsides. Here are some of the main cons of VC equity.

Dilution = loss of ownership and control

When you give up ownership to venture capitalists in exchange for funding, you lose the final say in your company's major decisions. To what degree you lose control will vary depending on how much ownership you retain, but in general, all founders that opt for VC funding will have a reduced grip on their company's operational and strategic reins. As investors become stakeholders, disparities in priorities and objectives might emerge, potentially steering the startup's long-term trajectory in unanticipated directions.

This becomes a bigger problem with each round of venture capital. Each time you give away a piece of your company, you lose more control and introduce more people who influence your company’s direction.

While this may not be an issue if everyone is aligned on long-term goals, it’s rare for this to occur every time a decision needs to be made. Many startup founders frequently find themselves in the middle of several board members with conflicting ideas, or, even worse, several board members who are all united on a plan that’s opposite to what the founder wants. Because of this, bringing on VCs can be a bit of a gamble, especially for founders who have an invested interest in staying true to their original vision. 

Unrealistic growth and valuation pressure

Venture capitalists often want to receive a 10x or 100x return on their investment. To meet this goal, they will give a startup an extremely high valuation and emphasize an ambitious growth trajectory to achieve this valuation. While this may initially seem very exciting to founders who want to hear that their businesses are valued highly and have good growth potential, there’s another darker side to this coin

Overly-ambitious growth projections can set the stage for intense pressure—often, pressure that isn’t necessary and is even unsustainable for long-term growth. Startup founders find themselves navigating a challenging terrain where meeting lofty expectations of rapid growth becomes imperative to validate the inflated valuation investors give, even if this means sacrificing business decisions that would make more sense for the founder’s long-term vision.

Founders can’t simply walk away from this pressure either: failure to meet these growth targets can lead to down-rounds, where the startup's valuation plummets. This translates to reduced financial support in future rounds and casts a shadow on the startup's appeal to other potential investors. The pursuit of unrealistic growth can push startups to adopt desperate measures, potentially steering them away from their original vision and goals in a frantic bid to match investor expectations.

Stringent requirements and a time-consuming approval process

Venture capital equity financing demands a rigorous due diligence process that involves extensive documentation, financial disclosures, and meticulous scrutiny of the startup's operations. And if that’s not hard enough, even getting a meeting with a VC to start this evaluation process can feel next to impossible, especially for startup leaders with no industry connections. 

This means that from catching investor attention to pitching to receiving the funding in your bank, getting VC funding can take months and consume tons of valuable energy and resources. While it does result in securing millions of dollars in funding, it also comes at the cost of diverting resources and attention from other critical business functions, such as product development or customer acquisition. 

Compared to other funding methods that could take a few weeks or even days to secure, VC funding can quickly become more effort than it’s worth.

When is venture capital equity financing most appropriate?

So with all this in mind, when is it best to get venture capital funding? And when should you opt for another form of funding? Here are a few types of startups and scenarios in which this funding model is particularly suitable and offers advantages over alternative funding options.

  • Early-stage startups with high growth potential. These startups require substantial capital infusion to expedite product development, establish essential infrastructure, and orchestrate rapid scaling. They also provide a high chance of creating a decent ROI relatively quickly. The alignment between these startups' hunger for swift expansion and venture capitalists' penchant for fostering rapid growth makes a symbiotic relationship that propels innovation and market presence.
  • Startups in SaaS and technology. Venture capitalists tend to favor SaaS and technology startups regardless of growth trajectory or business plan. These startups usually need a lot of capital to fuel initial research and development, but once the product is created, it can be scaled and create revenue fairly easily. This means that they grow fast and provide a high ROI, which is exactly what VCs are looking for.
  • Market disruptors with scalable business models. Venture capitalists are drawn to the potential of disruptive startups because they recognize the high ROI opportunity to back game-changing companies that could become industry dominators. 
  • Startups focused on global market expansion. Once again, high growth potential is key to attracting VC investors. Startups with aspirations to achieve global market dominance need high amounts of capital and resources to achieve international market penetration, and VCs looking to foster the next global giant are eager to supply it. 
  • Startups requiring extensive research and development. Finally, startups that require extensive research and development, such as biotechnology, healthcare, or clean energy, are well-suited for venture capital simply because they need massive amounts of money to be successful. They can also benefit from a VC’s business sense, as many founders at these companies have backgrounds in science, technology, or engineering, and may not know much about business. 

Revenue-based financing for startups: An alternative to VC equity

For startups that aren’t suited for venture capital, there are other alternatives. One of the best alternatives is known as revenue-based financing (RBF).

In this alternative financing model, startups commit to sharing a percentage of their future revenue in exchange for capital. It involves no debt or dilution, and capital is given in proportion to your current ARR. 

Here are some of the primary benefits of revenue-based financing:

  • No dilution. You get to keep 100% ownership of your company. 
  • Aligned interests. Although you don’t give up equity, since repayment is tied to your revenue, it's in your investor’s best interest to ensure your business succeeds. 
  • You still get connections and mentorship. Unlike debt financing, which just offers money, and equity financing, which requires losing control, revenue-based financing providers offer connections, mentorship, and business strategy, without taking over your business.
  • Flexible and debt-free repayment terms. Investors are repaid with a fixed percentage of your monthly revenue—so you’re never saddled with a giant payment you can’t financially handle during a slow month.

When is it best to choose revenue-based financing over VC equity financing?

Although revenue-based financing is an excellent alternative to VC equity in many situations, it’s not a perfect replacement in all cases. Here are some types of startups where opting for revenue-based financing makes the most sense. 

  • Mid- and late-stage startups. Because revenue-based financing is based on…well, revenue, you need a documented revenue history to qualify. Most RBF lenders ask for 3 to 6 months of revenue history, so if you own an early-stage startup that’s pre-revenue or hasn’t been generating revenue for very long, you probably won’t qualify. 
  • Startups with predictable recurring revenue. Enterprises built on recurring revenue models, such as SaaS or subscription-based businesses, are well-positioned to leverage revenue-based financing. The predictable and consistent revenue streams align seamlessly with revenue-based financing, both in terms of successfully qualifying for RBF and repayment ability. 
  • Cash flow positive startups. Startups with healthy cash flows and a track record of positive revenue are the most likely to qualify for large amounts of capital from revenue-based financing.
  • Startups that can’t qualify for debt financing. Debt financing often requires jumping through hoops, some of which have little to do with how successful your business is. If you can’t qualify for debt financing due to a low personal credit score or lack of collateral, RBF is an excellent alternative that only requires proof of steady revenue.
  • Startups with specific funding needs. Revenue-based financing presents an agile solution for startups seeking a targeted capital injection for a particular growth initiative or expense. Instead of spending months trying to get a multi-million dollar funding round from a VC, RBF allows you to get a smaller sum of money much more quickly. 

Scale your SaaS startup with revenue-based capital from Capchase

In navigating the journey of growing your business, remember that there is no one-size-fits-all approach. The funding option that makes the most sense for you now may not make sense a year from now, and many startups pool funding from a variety of resources.

If you’re not ready for a full VC funding round or want to avoid the dilution and loss of control that comes with it, consider getting revenue-based financing from Capchase.

With non-dilutive financing that scales along with your ARR and an underwriting process that can take as little as 48 hours, Capchase Grow can help you get the funding you need to grow quickly. 

Sign up now to get started, or see how much we can help you extend your runway with this runway calculator