Why NOT to do Venture Capital

Ah venture capital – the end all be all for some, a ticket to celebrity for others, and a chance to "invest in the future." Recent fund returns aside, VC seems like the place to be – you enjoy a better work/life balance than banking, you get to work with exciting technology (often shiny new toys as well if your fund has a hardware focus), and there's always that 1 in 1000 chance that you could source the next Facebook!

With all these perks, why isn't everyone clamoring to jump to venture capital as opposed to the hedge fund or buyout shop route? For all its positives, venture capital may not be all that it's cracked up to be.

This is an interesting topic for me because I've experienced some of it first hand. Working with VCs from a sell-side perspective, we had to pitch against them all the time – the reason being that it is easier to work with bootstrapped companies (read: no institutional money) that don't have a board with competing interests to those of the founders. More often than not, a VC's interests are not going to be 100% aligned with those of the founders. Remember, they are trying to generate a return for their fund, and they know that statistically speaking most startups fail. Thus they're trying to maximize their short-term ROI whether or not the company succeeds.

In speaking with a number of my friends who work in venture capital, I've been privy to a number of other gripes about actually working at a fund. This Quora post is spot on, and I will focus on a few key points it brings up:

  1. Politics among partners and who actually has the power to "get things done"
  2. A common complaint in dealing with VCs is that there are very few key decision makers – ie: the ones who actually have the power to pull the trigger and deploy capital for an investment. The hierarchy goes something like Analyst – Associate – Principal – Vice President – Partner – Managing Partner. Generally speaking (there are a few funds that deviate from this), only those at the Partner level and above can actually deploy capital. And even then, the partners individually only have so much bandwidth – in terms of allotted capital and board time. Savvy entrepreneurs know this, and will thus try to bypass junior level employees. It's a gamble because while there is a slim chance you will get an audience with a partner, there is a greater chance that you will piss everyone else off below him/her and handicap your chances for investment.

  3. Dealing with LPs and splitting time between investing, fund management, and raising the next fund
    The Quora post is gold on this question. LPs are extremely focused on brand name, and it is difficult to get them to focus on actual returns vs the competition. Moreover, from a partner's perspective, their role becomes more and more focused on keeping the LPs happy over time. It becomes an interesting little dance far more akin to politics than finance.
  4. Shattering entrepreneurs' hopes and dreams
    "Our projections show us making 500k this year, 4M next year, and 15M the following year! No, we're not cashflow positive, but we think a 10M Series A at a 40M premoney valuation will get us to where we need to be!" This pitch and countless variations upon it is not unfamiliar to anyone who has worked in venture capital. Entrepreneurs are fundamentally crazy – but they have to be. Without their undying optimism and belief in their product, vision, etc., we wouldn't have Facebook, Apple, Microsoft, or any other great company with a storied past that you can think of. Extraordinary companies are built by extraordinary people. That being said, the financial aspects are often an afterthought, and it becomes a VCs job to inject entrepreneurs with a dose of reality. VCs say "no" far more often than they say "yes." And they have to.
  5. All in all, venture capital is an extremely interesting career path, but it is not without its negatives. In light of the Facebook IPO performance and recent VC fund returns, what do you guys think?

Comments (16)

 
Jun 12, 2012 - 12:19pm

I find VC a very interesting area of finance and aspire to be in VC at some point. I think your points are valid, but you need to remember that VC is different than angel money and often serve different purposes with different conditions. One reason VC is so hot right now is the major tech boom that we have been experiencing with new apps coming out every week. I think that once this app boom settles down a little, VC will have to move to new areas for business. I am interested to hear people's thoughts

 
Jun 12, 2012 - 12:28pm

You're right in your analysis, but I don't think any of those are reasons NOT to do VC. Anyone going into VC has the same mindset as an entrepreneur; of all the partners at the VC firm I interned at, every single last one was a founding member or CEO of their own startup, or at least heavily involved in the process. I think VCs know this--it takes more than financial savvy or interpersonal skills to grow a company into exit. They have to want the company to succeed as much--or even more, sometimes, in the case of management consultation--as management does. If you're extremely risk averse and lose sleep over the notion of failure....that's a reason not to do VC.

I was taught that the human brain was the crowning glory of evolution so far, but I think it's a very poor scheme for survival.
 
Jun 12, 2012 - 4:19pm

VC is glorified because people tend to hear outlier success stories. This bias skews reality. Individuals even overestimate the percentage of success for run-of-the-mill projects/companies. Many VCs are not that profitable considering all the bad apples in a portfolio. There is some Pareto law whereby 20% successes can absorb the losses from the 80% but not every firm gets those rainmaking deals you hear about in the media. Also, unlike at HFs, IBs or even PE, you rarely hear about the left side of the tail disasters that happen to VC firms.

Being in alternative energy, particularly in the niche solar industry, has been quite mediocre.

Also not sure why Facebook is being discussed. VC firms that were invested made a killing. It was the MS and it's IB friends as well as the chasers and grandmas on the secondary market that really got housed. Anyways that company isn't worth more than 25B in my imo... it only made $1B last year and future free cash flows may actually decline. Facebook cannot advertise on mobile apps, it is going to face increased competition and everyone including pets and your grandma already have facebooks accounts... I just don't see the growth. Lol @ people who think its a buy here at a $60B market cap.

 
Jun 14, 2012 - 12:44pm

For crying out loud, we are not in a tech boom.

High Tech VC returns have been paltry for the past ten years.

And look at the companies we are taking public...Groupon? LinkedIn? Facebook? Zynga?

Ten years from now, at least 2 of those 4 probably won't exist.

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