Founders often chase larger funding rounds as a badge of success, but this strategy can lead to unexpected consequences. Through a simple thought experiment about business loans, we can understand one of venture capital’s most misunderstood mechanisms: liquidity preference.

Consider a business loan at 11% annual interest. Many savvy business owners would keep such a loan if they could generate returns above that threshold. However, the dynamics change dramatically when that “loan” must be paid back before the owner can access any returns – similar to how venture capital’s liquidity preference works.

This preference means venture capitalists must receive their guaranteed return before founders see any profits from an exit. The implications are significant: a founder might achieve a seemingly successful exit at $100 million, yet walk away with less than if they’d built a $50 million company with minimal venture funding.

The harsh reality is that many first-time founders don’t fully grasp these implications. They’re often sold on the narrative of “being ambitious” and raising substantial capital, only to later realise they would have retained more ownership – and potentially earned more – by taking a more conservative funding approach.

For founders considering venture capital, understanding liquidity preference isn’t just about reading the fine print – it’s about comprehending how it could fundamentally affect their ultimate financial outcome.

Check out the full episode HERE.