To hear venture capitalists (VCs) tell it, they aren’t too different from entrepreneurs. They build great companies. They create jobs. In short, they feel the entrepreneur’s pain. But for an entrepreneur to build a decent relationship with a VC, they need to understand just how different the two of them really are.
It is a fact of business life that compared to entrepreneurs, VCs have different loyalties, sometimes diametrically opposed interests, and a lot less at stake.
Having been interacting with VCs for about three decades now, I have learned some important truths venture capitalists won’t tell you.
- Experienced VCs know that less than 1 percent of venture-backed technology start-ups will ever achieve a $1 billion market capitalization. So they seek category potential, not current company performance, meaning they look for companies leveraging technology to build and dominate new market categories. If the category is big enough and the category king is dominant enough, current valuation is almost irrelevant. As a result, legendary VCs study category potential, not current total available market and ask the question: Can this become a giant new space? Can this founding team summon the balls, brains, and bucks to become the company that dominates this giant new category? If the answer to both is yes, they start drafting term sheets. If the answer is no, you are dead in the water.
- For as much as venture capital is in the news, you’d think these high-end investors had funded half the successful businesses in the country and beyond. But the reality is much narrower. VC is a very select form of financing. In the United States, which is the most active VC market in the world, only about one thousand businesses get new financing per year. That’s .025 percent of the approximate four million businesses started in the United States each year. Obviously, not all those are VC quality to begin with, but even so, it’s still only a minute percent of companies seeking VC funding get it. The odds get even worse for entrepreneurs in Canada, Europe, or Asia. There’s actually a lot more money to be found in family offices and the pockets of high-net-worth individuals. But venture capitalists won’t advertise that. They want to perpetuate its huge mindshare and mythology.
- Similarly, they don’t want to admit that as an industry, venture capital’s return on investment is seriously behind that of the public stock market. From 2007 to 2016 the average internal rate of return for American venture capital funds was 6.1 percent annually. During the same time, the Nasdaq rose 10.3 percent annually, and the Dow Jones Industrial Average returned 8.6 percent a year. Given that VCs skim the first 20 percent of annual venture fund profits off the top, people who invest in them have begun to wonder what they were paying for. If you intend to make the right decisions, it’s time to wake up, smell the coffee, and recognize facts from fiction.
I am often asked if VC money alone can make a start-up successful. You must understand that venture capital is a first step, but it’s never enough on its own. Judging from how most VCs fund more losers than winners, there are plenty of examples that attest to that. But I really believe it all depends on the type of business you are in.
Bottom Line:
Don’t be impressed by these people. More bureaucratic idiots than meets the eye.
With less capital it’s harder to scale, and that’s actually a good thing. Scaling too soon forces you to grow and make decisions before your company is ready. Expectations are lower with less capital. And your milestones will be more manageable. Also, larger amounts of capital lead to unnecessary dilution at a lower valuation. Conversely, smaller amounts of capital allow you to preserve more ownership and can lead to higher valuation in future rounds.
The sooner you sell equity, the more it will cost you in the long run in loss of leverage as well as dilution. Instead I always advise entrepreneurs to do everything they can to get their company off the ground and build traction prior to raising funds.
Remember the key is never to be slave to capital but let capital be your slave. You lose your freedom you lose everything. Freedom and creating fuck you money should work in tandem…. always
By:Â Ziad K Abdelnour
Ziad Abdelnour is also the author of the best selling book Economic Warfare: Secrets of Wealth Creation in the Age of Welfare Politics (Wiley, 2011) and of the upcoming book  Startup Saboteurs: How Incompetence, Ego, and Small Thinking Prevent True Wealth Creation coming out in May 2020.
Mr. Abdelnour continues to be featured in hundreds of media channels and publications every year and is widely seen as one of the top business leaders by millions around the world.
He was also featured as one of the 500 Most Influential CEOs in the World.
