9 Unexpected Pitfalls of Raising Capital (And How to Avoid Them)

Guest author Scott Gerber is the founder of the Young Entrepreneur Council.

Raising rounds of venture capital is the goal for many companies: An influx of cash is certainly the fastest way to jump-start your growth and start hitting key milestones more quickly. But venture capital isn’t a silver bullet, and it’s not the right fit for every company.

To better understand the benefits and drawbacks, I polled nine successful entrepreneurs from YEC to get their thoughts on some of the biggest pitfalls to be wary of, and advice on how to avoid them entirely.

1. You Could Give Away Too Much Too Soon

It is extremely sexy to be a “venture-backed” startup. This leads many entrepreneurs to seek venture capital as soon as humanly possible. This, however, is not always in the best interest of the entrepreneur. The longer you can wait to accept investment, the better. A track record will increase your valuation and thereby decrease the percentage of the company that you need to sell to raise the requisite capital. Remember, venture capital companies are in the business of making a return on their investment; act accordingly.Matthew Moisan, Moisan Legal

2. It’s Hard to Maintain Culture and Quality

When you’re tight on money, it’s easy to be rigorous in your hiring process; a bad hire can be a costly affair. Conversely, after a new round of funding, the pressure to grow quickly may lead to a decrease in the quality of new hires as you say yes to the borderline people you used to reject. The result could be a dilution of the company’s culture as the droves of new hires can’t assimilate quickly enough.

Two suggestions:

1. Stay disciplined in your hiring process. Make sure you have your long-term goals in mind. Ask if this person will be a great employee in three years.
2. Codify your company values and devote a significant portion of your onboarding process to conveying culture. AJ Shankar, Everlaw

3. It Can Lead to Excessive Dilution

With a new round of financing, the true value of your business does not necessarily increase. Once you raise money, the expectations for your company skyrocket. If you are unable to grow bigger, faster, you might find that you’ll have to give up more equity to investors under far less favorable terms. At some point, your equity is diluted so much that you are no longer motivated to grow the business, since you’d get a minuscule percentage of the upside during an exit. Capital helps, but be very careful about how much you raise and when you do it. Danny Wong, Grapevine

4. It Can Lead to Overspending

Raising money provides a great jolt of energy to a company. You finally have the resources to execute your plans: hiring a CTO, getting that PR firm, spending money on Facebook advertising. Other expenses pop up, too—maybe a small team or year-end bonus that you wouldn’t have given otherwise. Certainly a bump in salaries. You hire that one extra person who wasn’t on your radar. While you’re managing the bank account closely, the team only knows that there’s a big amount in there. They don’t think about the monthly burn and they might start expecting daily lunch, nicer team events, or more swag. Manage your team’s expectations and only spend on what matters. Aaron Schwartz, Modify Watches

5. It Can Cause Premature Scaling

One fatal side effect of raising capital is premature scaling, which is when startups overspend too early on expensive marketing campaigns, hiring sales people, and building the company before customer adoption. According to a report from Startup Genome, premature scaling is the No. 1 cause of startup death. Raising capital often misleads first-time entrepreneurs into assuming that their business model has been validated. Although raising VC is a milestone, it is not an indicator of success. It’s important for founders to realize that only when they have a scalable business model combined with a repeatable sales process can they be certain that they have a sustainable business. Vishal Shah, NoPaperForms

6. It Opens the Door for External Influences

Most entrepreneurs realize that raising capital means losing some control and ownership of their company. Not as obvious is how influential these new owners can be. So while you may maintain control through a voting majority, you might get pushed and pulled in directions you might not otherwise have gone. For example, I’ve seen small companies go public prematurely as their initial investors demanded an exit strategy. Disaster always ensued, but in each case the pressure was great to do so. Keep in mind that while on the surface your goals may seem to be aligned, your funders may at times have their own best interest in mind, which don’t always coincide with the company’s. Nicolas Gremion, Free-eBooks.net

7. You May Improperly Value Your Time

One of the largest problems that inexperienced entrepreneurs are not aware of when raising capital is that the funds are not always serious when investors schedule meetings and begin diligence—all of which can suck up critical time for an entrepreneur. Raising money is a full-time job and can pull any founder or CEO away from managing their team, executing on customer contracts, and refining the product in the market. A good way to solve this problem is to create a clear sense of urgency with funds so investors do not request meeting upon meeting upon meeting. This forces the investor to best utilize the founder’s time and enables founders to cherrypick the best place to focus their energy. Zoe Barry, ZappRx

8. It Can Lead to Excess Scrutiny

Entrepreneurs sometimes chase investor dollars without clearly identifying why they need the money and how they will use it to generate profits. In so doing, they court disaster. Anybody that gives you a dollar will want to have a say in your company. They will scrutinize how the money they gave you is being spent. If it produces profits, life is good. If it’s misappropriated (fails to produce a noticeable bump in productivity, brand awareness, or profits) the bright lights, critiques, lawyers, and forensic accountants will pay you a visit. To avoid this scenario, entrepreneurs and investors need to have honest discussions and establish measures of accountability and performance.Souny West, Chic Capital

9. Emotion Will Run High (So Hire a Lawyer)

I know you want the money to execute on your dream, but don’t let the emotional supercharge take over. Make no mistake that investors want one thing: more money as fast as possible. And money is valued more highly than your blood, sweat and tears. Investors are extremely sophisticated and there are a lot of strange clauses that make their way into contracts. Avoid regret later and hire a lawyer to help you negotiate a fair deal and explain to you exactly what you are signing. Lawyers are expensive, but you’ll be glad you spent the few thousand dollars now rather than realize a few years from now that the fine print cost you a lot more. Jeff Denby, Pact Apparel

 

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