Five Myths About Venture Capital
Demystifying Ideas That Don’t Accurately Represent VC
[To all the new subscribers - welcome! I hope you’ll find this newsletter interesting and informative. To those of you who’ve been on the journey with me for more than a few days, thank you! I don’t take your attention for granted]
In a prior post, I detailed how I transitioned from a role in sales management to a partnerships and business development role working with venture capitalists.
While it’s only been a few months in this new capacity, I’m already learning a ton and recognizing how different things really are from what the general public perception is.
For example, I’ve connected with a lot of people who are looking to learn more about venture capital or get into the industry. During these conversations, I often hear interesting preconceptions about VC that add more allure or complexity to the industry than I think is deserved. Therefore, I think it would be helpful to demystify some of the ideas about VC.
Here are five myths that I’ve heard that I think are worth exploring:
Most startups raise money from venture capitalists. This is false. According to long-standing data, less than 1% of all startups raise funding from VC. While it’s easy to assume that this would be a default funding path for startups, it’s far less common than that. Many businesses aren’t built for VC funding by the nature of their business growth prospects. Furthermore, it’s extremely hard to receive funding even when you are pitching investors. Ever see an episode of Shark Tank? While the show is definitely entertaining, it makes it look easier than it is. What’s more common is getting small business loans or raising money from friends and family.
Venture capital firms make money when their investments go public or get acquired. Yes, but that’s not the primary way they make money. Because most startups fail, most don’t go on to get acquired or go public. As a result, VC firms have a model that drives revenue to their business that is independent of these successful exits. This is called management fees, which is typically 2% of the fund size (example: VC firm raises $100 million from university endowments or pension funds, they keep $2 million to run and operate the firm). Beyond management fees, yes, the big upside comes from the 20% carried interest they receive from the fund when companies succeed, which means they get 20% of what’s earned above the fund amount when companies go public or get acquired.
To land a job in venture capital, you have to have gone to business school or had a job on Wall Street. This is mostly false. While a traditional MBA and investment banking background are common in VC, it’s not the only way. There are tons of folks in the industry who are former startup founders and entrepreneurs, former startup executives or operators, prior angel investors, or just someone with great skills of adding value to companies. Each path into VC can look a little different. For a really riveting example of how some get into VC, I would strongly recommend reading this, which was written by a friend.
Venture capitalists take a big risk when they invest in any startup. False. While the industry is built on placing long bets on risky companies, the approach of most VC investors is far more diversified and risk-averse than you may think. VCs use a portfolio strategy to place small or medium-size investments across a large number of companies and only expect one or two to really provide large returns. Generally, for each fund they raise, they expect more than half to fail within a few years, 20 to 30 percent to survive but not become a spectacular winner, then roughly 10 percent to become that unicorn that everyone is chasing.
The VC industry is relatively young and became established during the dot-com era. This is definitely false. While some people may believe that the rise of companies like Google, Paypal, or Facebook was the genesis of the industry, it’s actually been a well-established investing class for decades. In the 1970s, as silicon emerged as a core component for the computing industry, marquee VC firms like Sequoia Capital and Kleiner Perkins were becoming staples within what’s now known as Silicon Valley. Since then, thousands of VC firms have been established to fund technology startups. The industry is old yet still operates in a fundamentally similar way than it did when it was first created.
Are there other myths about VC that you’ve heard and want to know if it’s true? Drop in a comment and I’ll let you know what I think.