Equity funding moves the risk off the founders' own backs

The argument

A second argument for this position concerns who bears the downside. Proponents point out that the alternatives to outside equity are funding a company from savings, from personal borrowing, or from revenue squeezed out of the business from the start. Each of those places the risk on the founders directly: the mortgage, the credit, the years of unpaid or underpaid work, and the household that depends on all of it. Equity capital does not. The investor accepts that most of their investments will fail and prices that expectation in, so a founder whose company does not work out loses the venture and their time but not their house. Proponents argue that this changes who is able to attempt the thing at all. Self-funding selects for people who already have money or who can fall back on family, which is a narrow pool; an arrangement in which someone else supplies the capital makes it possible for people without inherited means to start a company. On this view outside equity is the mechanism that opens entrepreneurship beyond those who can afford to lose, which they regard as a point in its favour quite apart from the growth it funds. Defenders of the position also note what the arrangement makes possible inside the business. A company that has to be profitable from the first month cannot take on anything that needs years to work, cannot pay people properly before revenue arrives, and cannot survive the discovery that its first idea was wrong. Capital in the bank buys the chance to be wrong and continue, which proponents argue is the normal condition of building something new. On this account startups should take venture capital, because it transfers risk to people equipped to carry it and buys the room to make the mistakes that building anything requires.

Premises

Counter-arguments

Critics argue that the transfer of risk is less complete than it looks. Founders typically take below-market pay for years, concentrate their wealth in illiquid shares, and under standard terms see investors paid out first, so in a middling outcome the founder can end with very little while the investor is made whole. They also argue that the room to be wrong is conditional and short: capital arrives with expectations attached, and a company that misses them finds the room gone at the next funding round. Others note that bootstrapping is not the only alternative, since revenue-based finance, grants, and customer prepayments fund companies without surrendering equity or control.

Rejecting the premises

[Rejecting P1] Critics object that bootstrapping is not the only alternative, so the choice is not between outside equity and personal liability. [Rejecting P2] They argue the transfer is incomplete, since founders take years of below-market pay and investors are paid out first, leaving a middling outcome worth little to the founder. [Rejecting P3] They reply that the room to be wrong is short and conditional, because capital arrives with expectations and a missed target removes the room at the next round. [Rejecting C] They conclude that risk is shifted in form rather than in substance, and that what is surrendered for it is control.