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VC Funding: What You May Give Up Other Than Equity

 

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Investors will demand accountability and some control over your startup

My Kauffman Fellows classmate Anarghya Vardhana, a partner at venture capital firm Maveron, has what might be called “The Talk” with every startup founder before she invests. “You’re getting another person who has a vested interest in your business."

“Hopefully that’s good,” she continues. “But the reality is that it’s not always that way. There could be potential misalignments between what we as the investors want and what the founders want.”

Securing that first big slug of venture funding is cause for celebration, and for good reason: you’ll get cash, connections, credibility and much more. But accept that check with eyes wide open. Venture money comes with strings to go with that percentage of your company that the VCs now own. It is critical to understand what those things are, and to make sure you and your investors see eye-to-eye on things like company trajectory, culture, diversity and values.

Get ready for hypergrowth

For starters, once you accept VC money, there’s an implicit agreement that the only path forward with many investors is hypergrowth. “Nowadays, there’s this automatic, ‘I have an idea, let me raise venture capital’ attitude,” Vardhana says. “Rather than really thinking through whether that’s the route for them and the company they’re trying to build.” In particular, if your vision is to grow your business slowly, VC may not be right for you.

Make room at the table for additional owners

Of course, there are tangible advantages to landing with a venture firm, especially a well-regarded one, beyond cash. Any venture capitalist worth the job title will bring to the table both their experience and their network. They can help hire key people and make introductions to potential customers. They are a sounding board and a voice of experience in the room.

Yet taking venture means giving up some level of control. You — or you and the rest of your founding team — will no longer be the sole arbiter of decisions.

“Most entrepreneurs, especially inexperienced ones, tend to pay attention to how much money they’re getting and the percentage of their company they’re giving up,” says Joe Beninato, who has been involved in founding four startups. Entrepreneurs tend not to care as much about board composition and liquidation preferences, clauses that dictate the order of payouts in case of liquidation of the company, Beninato adds. “Those are the things that can end up biting you later down the road.”

Be ready for additional accountability

When accepting venture funding, at least at the A Round and beyond, a founder is likely to cede one or more board seats to the new investors. That means a regular cadence of board meetings, phone calls and possibly other face-to-face meetings. “They’re not going to give you direct advice. Or the good ones won’t,” says Michael Wolfe, another serial entrepreneur who has been a founder or early employee at five startups. “What VC board members tend to be good at is pattern recognition: patterns of growth, the tradeoffs of different decisions. They give you things to think about. They help you think through problems and help form decisions.”

“What VC board members tend to be good at is pattern recognition”

When things are going well, the VC board member can be a close advisor along with others in the network that any good founder has established. “I’ll have breakfast or drinks in between [board] meetings with board members,” Wolfe says. “To pick their brain, to talk about how things are going. And express the frustrations inevitable as you build a new company. This helps you put things into perspective.”

A board also means accountability — something that can be very helpful, especially in the case of less experienced founders, but can feel uncomfortable for those accustomed to running things their own way. Taking venture money also means a level of transparency operating as a steward of capital from your investors. You can’t suddenly decide to pay yourself $300,000 a year.

“A board…can feel uncomfortable for those accustomed to running things their own way”

“I have a fiduciary responsibility to my partners and my LPs to do what’s right for them in terms of driving returns for the fund,” says Vardhana, using the shorthand for “limited partners,” the investors who provide cash to VC funds. “When you take on institutional investors, the projection of the company changes. The expectations change.”

You’re still the CEO

The CEO still runs the company even after the venture capitalists have entered the picture, setting the tone for both the company and for board meetings. The executive team establishes goals and then executes and delivers (or doesn’t deliver) on them. A good VC is there not to micromanage day-to-day decisions but to help determine the course the company takes — and help problem-solve when a company hits the inevitable snag. “Almost all operational decisions are with the CEO,” Wolfe says.

Yet the board will certainly be weighing in on key decisions. They might not be in charge of personnel, but they’re going to want to meet that new vice president of sales you’re thinking of hiring. “Then imagine your lead investor coming back and saying, ‘I wasn’t impressed,’” Beninato says. “You probably have a limited number of times you ignore their advice, which you do at your own peril.”

“Imagine your lead investor coming back and saying, I wasn’t impressed”

A common refrain about corporate boards is that their primary job is to hire and fire the CEO. “That might be true of publicly-traded companies but at a young company, especially when you’re bringing in VCs who have lots of industry experience, the discussions and decisions being made at the board level are much broader and go well beyond the hiring and firing of the CEO,” says Scott Dettmer, a Silicon Valley-based lawyer who has been providing counsel to the founders of tech startups dating back to the 1980s. “There are many strategic business issues that get vetted and discussed and really decided at the board level,” Dettemer says. The direction of the company. The rate of growth. Budgets. The hiring and firing of the management team. All are potential sources of tension and frustration for the entrepreneur, he adds.

Your control could weaken over time

A founding team typically retains control of the board after that first round of funding. But that inevitably changes if there are more rounds of financing, as is common for successful startups, says Dettermer. And it’s not the ownership percentage that matters, he often has to remind founders, but the majority vote of the board. “When we coach founders, we tell them to keep their eye on the prize and stay focused on the board, because that’s what really matters.”

“When we coach founders, we tell them to keep their eye on the prize and stay focused on the board”

That’s the same advice offered by Beninato. He had thought he had a good working relationship with at least two of the three venture capitalists who served on the board of one of his companies. But there was no alignment with the third, who at some point decided Beninato was not up to the job of running the company. When things came to a head, the other two VCs sided with their fellow investor, and Beninato was pushed out of his company.

Think before giving out board seats, he counsels: “People who gave away board seats willy-nilly usually live to regret that decision down the road.”  

Takeaway: VC-funding entails ceding some control to investors; make sure you share vision and values

That first VC check will transform your startup. Investors now believe in your idea and are ready to roll up their sleeves to help you succeed. But their money means shared ownership and control. It’s also the beginning of what’s likely to be a years-long relationship. Make sure you are aligned.

You’ve just landed your first VC round: You have a few million in the bank and still own, say, 75% of your company. Congratulations.

But remember this: Your startup is no longer what it was when it was just you and your cofounder. You are now accountable to new partners who will have some say in how you run things, so it is critical that their vision aligns with yours.

Visit Startup Insights for more on what you need to know at each stage of your startup’s early life:

Getting Started

Startup Incorporation

Startup Finances

Startup Metrics

Startup Accelerators

Equity Dilution

Gaining Momentum

Startup Bootstrapping

Investor Emails

Cap Tables

Burn Rates

Ready to Raise

Friends & Family

Angel Investors

VC Funding

VC Choices

This material, including without limitation the statistical information herein, is provided for informational purposes only. The material is based in part upon information from third-party sources that we believe to be reliable, but which has not been independently verified by us and, as such, we do not represent that the information is accurate or complete. You should obtain relevant and specific professional advice before making any investment or other decision. Silicon Valley Bank is not responsible for any cost, claim or loss associated with your use of this material.

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