Jul 30 2007

Raising Money From Venture Capitalists Versus Investment Banks.

Q: We’re a small startup with an innovative product in the social-networking / communications / UGC monetizing realm, at a pre-alpha stage of development. We have a number of potential deals on the table, the most attractive of which is to raise a large sum ($4mm) through a private placement with an investment bank. This deal has no strings attached, comes with a very high pre-money valuation and would cover two years of operating costs – SOUNDS GOOD TO ME!

Every VC we’ve met with expresses what seems to be prejudice against investment banks and the strategy we are considering, pointing out that they, the VCs, are the “smart money” with the “contacts” and “experience” as well as some other arguments as to why we should give up WAY more of our company to THEM for WAY LESS money.

What’s your word on this conundrum? My partner and I have talked to a number of entrepreneurs and they all say “stay away from VCs, take the money and run your business!” In fact, most of the people we talk to have had very negative experiences with VCs and question the notion of “smart money” altogether.

A:  (Jason)  It goes without saying (but I’ll do anyways) that I think reputable VCs are indeed smart company builders who will provide learned guidance in how to build your business and provide much more to your success than just money. 

I’m not here to bash raising money from investment banks – plenty of our companies at some point in their lifecycle do just that, but consider some of the advantages raising money from a VC versus an investment bank:

– Venture Capitalist will add a lot more value as board members being professional small company board members;

– Venture Capitalists will price your deal accordingly for the funding round.  Banks have been known to price early rounds too high and thus making future rounds very hard to consummate without diluting your first investors;

– Venture Capital financing will normally bring 1-3 shareholders to your company, whereas investment banks tend to bring many different individuals.  Consider information requests, annual meetings and issues involving dealing with individual shareholders if your business does not scale as planned; and

–  The bank may not be able to raise the money.  It’s not investing personally, rather attempting to find others to invest in your company. If they fail, you’ve wasted a lot of time and money drafting a PPM, etc. – documents that you wouldn’t create if funding via a venture capitalists.

As for “no strings attached” – I’m not sure what you mean, but banks only get paid if they get the deal done, so make sure they have your interests in mind, not just theirs.

One last point: I’m not sure where you are located, but in our neck of the woods, I think most entrepreneurs have had positive experiences with the VCs.  Again, you need to make sure they are reputable, but most professional VCs dealing with sophisticated entrepreneurs have good experiences together in both successful and problem-esque companies altogether.