Mod Note: Throwback Thursday: this post originally went up on 10/5/12.
I went through a few rounds of interviews at the fund that I now call my employer, I was asked insane questions, easy questions, technical questions, and borderline bizarre questions, but I was not asked the most obvious question I expected to answer. What is Venture Capital?
I thank all the deities in the world and nearby galaxies that I wasn't asked this during the interview process! Had I given the answer I was prepared to give, the one I meticulously crafted after several, long minutes spent browsing the interwebz. I will have been unemployed now.
The first couple of weeks on the job were truly a humbling experience. I got laughed at, called a "Sell Side Scroog", and umpteen business plans (most of which were rejected ventures) were thrown on my desk while a senior analyst blurted the word "learn" in a tone that suggests sorrow and sadomasochism.
And so I am...learning, and reading and writing and so far I have had multiple and consequential "Duh", "Aha", "Reallyyyyy????" , "WTF", and "Ohh, makes sense" moments. My favorite light bulb ever lit up when I was finally able to tell what Venture Capital is and isn't.
Venture Capital: investing in entrepreneurial enterprises. By definition, an entrepreneurial enterprise has negative cash flow and three major characteristics:
1- The owners are the managers
2- Highly volatile and unstable
3- Significant portion of the owner's net worth is tied to it's success
Why would anyone in his or her right mind invest in a highly volatile - cash burning idea, you might ask?
They don't. They invest in the promise of three elements:
1- The team
2- The rapid growth potential
3- Realization at exit
How do VCs determine which egg is the golden one?
Sine the traditional sense of financial analysis/modeling doesn't help here due to the obvious lack of historical data, and since most start up projections would be the subject of eternal jokes for most sell side transplants, the determination happens through:
1- The gut. An educated and honed gut is crucial for success in this business
2- Industry knowledge. If you are evaluating a tech startup you better know your tech industry
3- Risk-Return analysis
4- Belief in the team
Seems easy, how come some golden eggs fail to hatch into cute little chicks?
In a hypothesis where you make only all the right decisions, two out of your three decisions will be less right than right. Two out of three mommy chickens kill the fetus before it cracks the shell.
Why are VCs so uptight and selective?
1- Nine out of 10 startups fail
2- Negative cash flow phase ranges between 36 and 92 months depending on the industry. Feeding mommy chicken for 92 months is a little expensive
3- Exit takes an average of three to seven years - three to seven years! That's longer than most marriages nowadays
4- If you invest for equity, you want your stake to be worth the most it could
Bullbananas, tech ideas take off really fast and provide off the chart returns
This might be a little shocking, but not all start up ideas are tech ideas. Consumer products is a very prominent player in the scene, so is alternative energy and food & beverage.
Okay this is getting really long and I have some work to do. I might or might not have also realized there are still some aspects that I am not 100% clear on. So I will poke, probe and squeeze some more answers and hopefully I will have more useful information.
If you have any questions, please do ask; that will help me ask more questions to get better answers, and if you can correct or clarify anything I would be forever grateful.
Have a fantabulous weekend, y'all.