Opinion: Why some startups are starting to see venture capital as their worst enemy

DoorDash keeps attracting investors without turning a profit

VC’s funding monopoly faces a mounting backlash from company founders, but what comes next?

DoorDash, the food-delivery service, has yet to earn a profit, but that hasn’t stopped investors from trucking cash to its porch. The firm held a US$600-million financing round this May, more than tripling its value from last August, to US$12.6 billion.

This may sound like a dream scenario for startup founders—endless capital to propel their companies’ valuations to the moon. Indeed, massive sums of venture capital have helped spawn some of the world’s most successful companies, like Facebook, Google and Spotify. And venture capital firms are more eager than ever to pony up, deploying a record US$130.9 billion last year, while holding a decade-high US$128.5 billion in reserve.

Just one problem. A small yet growing cohort of entrepreneurs is realizing that venture capital isn’t always right for them or their businesses. In some cases, in fact, it’s a one-way ticket to early implosion…or worse. While a huge Series A and a write-up in TechCrunch may still be the holy grail for many founders, an increasing number are waking up to the downsides and exploring different options altogether. 

The lure of big money

For inexperienced entrepreneurs, it can come as a rude awakening to discover that VCs’ interests don’t always converge with—and are sometimes at odds with—their own. A VC fund sells the promise of massive returns to its clients—limited partners, or LPs—typically through a windfall initial public offering or an acquisition within five to 10 years of a company’s funding. Those time frames and growth expectations, however, won’t align with all companies, especially if they’re building for the long haul or still figuring out product-market fit. 

Worse still, once on the VC hamster wheel, many founders find themselves chasing the next funding round simply to sustain growth and satisfy investor expectations—often to the detriment of their companies’ core functions. Investors, through their board control, voting rights and financial terms such as full-ratchet clauses, often oblige startups to grow aggressively—faster than their competitors and regulators, faster than they can fix their deficiencies and faster than they can build a sustainable business model or even a decent product. Some critics have compared this habit of force-feeding cash to startups to foie gras producers overstuffing their geese. 

Examples aren’t hard to find: investors poured US$118.5 million in four separate rounds into Juicero, the now-failed maker of a US$400 wifi-enabled juicer that couldn’t squeeze juice better than bare hands. But that’s a drop in the bucket compared to Uber Technologies. The company may have enjoyed a US$82.4-billion IPO this May, but it’s lost more money faster than any other firm in history (and warned in its IPO filing that it may never earn a profit). For all its disruptive power and capitalization, Uber still hasn’t figured out how to run a sustainable business.

Founders might believe that lavish funding and soaring valuations will at least fill their pockets. But again, read your term sheets carefully. Financing deals can dilute founders’ holdings and include clauses that strip them of voting rights and board seats. When investors sold fantasy sports-betting startup FanDuel last year at a US$465-million valuation, they exercised their rights as majority shareholders to shut its five founders out of any proceeds. So much for the VC rocket ship to financial freedom.  

Bucking the VC playbook 

Of course, VC isn’t the only means of financing a business. In fact, it’s partly a historical blip—a model that exploded in popularity after the dot-com bust to service a new generation of companies that could be built on the cheap using cloud servers and then sold quickly. But as backlash grows, older, tried-and-true approaches are regaining popularity. 

After all, there have always been ways to build businesses without following the VC playbook. Just look at how Phil Knight built Nike from selling shoes out of his car. Bootstrapping, borrowing and reinvesting revenue may seem quaint, old-fashioned and slow, but that deliberateness can give entrepreneurs time to grow their companies more sustainably—even if it’s just until they’ve fleshed out their products and processes, and are better equipped to absorb outside funding. 

For all its simplicity, this approach has real advantages: the chance to fine-tune product-market fit before scaling, retain equity, maintain control over company direction and culture, and be in a better bargaining position when it does come time to seek outside funds. Social-media software company Buffer chose early profitability over rapid growth, allowing it to raise funds on better terms and with more control. It gave up just 6.2 percent of its equity and no board seats in its 2014 Series A round. Buffer used profits to buy out its VC investors last year.

Meanwhile, there’s a growing number of newer funding options to help companies get off the ground. Equity crowdfunding services like Crowdcube help startups engage with broad groups of investors, but they’re still restricted by securities regulators in many countries. Kickstarter and similar crowdfunding sites have been around longer and offer product rewards to backers, rather than equity. An overlooked advantage here is that early backers often become early customers and ambassadors. Their actual stake in the business may be small, but their enthusiasm and word-of-mouth support is outsized, which can pay real dividends when building product awareness.

For startups looking to avoid dilution altogether, Clearbanc offers US$10,000 to US$10 million in funds in exchange for a steady share of revenue until that money is repaid, plus a flat fee of 6 to 12 percent. Clearbanc doesn’t take equity in companies it funds, leaving founders with total control. And unlike loan interest, its flat fees don’t compound as time accrues.  

Other models are blurring the lines between funder and founder. As a young entrepreneur, I was always hungry for expertise as much as financing—an experienced partner willing to help build a business, as opposed to just an investor willing to take a gamble on one. The so-called venture build approach, popularized by Twitter founders Biz Stone and Ev Williams, sees funders become active and heavily vested partners in building a startup, providing a mix of capital, expertise and network. This can help seed-stage companies quickly find their footing and start to scale more sustainably.

Venture capital may be a more powerful force than ever before, but its alternatives have never been so compelling. Old playbooks and new ones alike offer competing options for entrepreneurs and disenchanted founders. Meanwhile, simple economics suggests that some models may not be built to last. Ultimately, all businesses need to turn a profit. User acquisition is great, but once upon a time we had a name for growth that only digs a company deeper into the red: unsustainable.

Shafin Diamond Tejani is an investor, entrepreneur and founder and CEO of Vancouver-based Victory Square Technologies, which supports technology startups through sustainable growth.