Five Myths About Venture Capital

 

 
Myth #1 – Venture Investing is a Good Way to Make Money

As the chart below illustrates (courtesy of Flybridge Partners), unless you are in the top 10% of investors, venture capital is a very bad investment, both in gross returns and especially on a risk/reward basis.
 

For the top 5-10% of venture investors, VC is a spectacular way to make money… but only for the top 5-10%. 

Myth #2– Venture Capitalists are Rich

A few VCs are rich but, again, only the ones in the top 5-10%.  Almost all VC make relatively low salaries, especially compared to their peers in investment banking, hedge funds, consulting and other areas in which they might have made a career.   
 
Unfortunately, because their investments will not pay off, that low salary is all most VCs will ever make.  Carried interest from funding the next Google just isn’t going to happen.

In the far right column of the slide below, you see that the number of VC firms peaked in 2001 at 1883.  By 2009, that number was 1188; in other words, 37% had gone out of business.  By now (2012), the failure rate has probably reached close to 50%.  How many industries do you know in the last nine years where nearly 50% of the firms have gone out of business? Not many.
 

If your primary goal is to make a lot of money, you are better off in investment banking or hedge funds, etc.  Only do venture capital if you truly enjoy it.

Myth #3 – You Must Connect to Silicon Valley in Order to Succeed

a.  Here is a list of several of the most valuable/successful companies in the last several years and where they were founded:

Facebook: Boston
GroupOn: Chicago
Living Social: DC
Demand Media: LA
Tumblr / FourSquare / Twitter: NY

b.  The most successful venture fund in the last decade (2000-2010)?  GRP Partners.  Ever heard of them?  Probably not.  Know where they are based?  Los Angeles.

c.  Seven of the top eight venture bloggers are not in the Valley.  The lone member from northern California is Paul Graham of Y Combinator.

Myth #4 – These Days it Costs Less to Build a Large Company

Wrong.  It costs less to build a SMALL company.  It still requires a huge amount of capital, as much as it ever did or more, to build a large company, even in the “capital-efficient” Internet space.  The list below shows some recent winners and the amount of private (non-IPO) investment they raised:

Facebook:                  $2.34 billion
Groupon:                    $1.14 billion
Twitter:                       $1.16 billion
Zynga:                        $800 million
Dropbox:                    $257 million
AirBnB:                       $120 million

Myth #5 – Ideas Matter

Ideas are commodities.  Even seemingly “original” ideas almost always derive from ideas already in the market and, if the idea is good, probably three or four people already have the same idea somewhere else.

Most great companies are not based on original ideas but rather improve on existing ones.  Facebook launched two years after MySpace.  Before Google, there was Alta Vista, Lycos, Yahoo and half a dozen other search engines.  I could go on but you get the point.  As Paul Maeder of Highland Capital Partners points out, even Einstein said he had just one original idea in his entire life. 

So what matters?  Execution of ideas.  Who executes?  People.  Backing the right person is what matters, much more than backing the right idea. As Maeder says, the most important investment calculation is evaluating the entrepreneur and whether “the Force is strong in him”.
  • Pingback: 5 myths of venture capital (and how it applies to missions)

  • Gringo!

    Scary…. Some do seem to make a business of picking winners though. Meaning between years, those in the top 10 pct seem to stay in the top 10 pct even as the portfolio turns over.

  • Gringo!

    Also, maybe the stage affects the end result – late stage vs early stage. Or maybe there’s a stage sweet spot – series A/B, after the business has aged a little bit and hit a few key milestones. Finally, related to the below, maybe you can make your fortune a little bit but using roll-up strategies or synergistic portfolio approaches where the portfolio companies help each other out.

  • http://GrasshopperHerder.com Tristan Kromer

    While I like the first point and agree with the conclusion of others, the proof points here are sketchy.
    Myth #2 – The % of firms that go bankrupt says nothing about the salaries of individuals or their net wealth before, after, and during their VC years. (The conclusion would not surprise me at all, but it’s not proven by your facts.) Also depends on what you mean by rich. I have yet to meet a VC living in a one room studio apartment. A low VC salary would be considered quite wealthy by some.

    Myth #3 – I agree with this point, but picking a few high profile companies and showing their location says nothing about whether it’s better to be based in the valley or not. There is some good information backing your point if you look around a bit for stats of the likelihood of being funded depending on location.

    Myth #4 – This surprises me. I have never heard anyone say this where I live (Silicon Valley). The similar and often repeated statement here is that it costs less to start a company and bring it to a point of discernable traction. Not scale it to massive sizes. Perhaps this myth is only in Brazil.

    Myth #5 – This is true from my perspective, but has less to do with Venture Capital and more to do with whether or not entrepreneurs should get over themselves and their “great” ideas.

  • http://twitter.com/sommacal Tiago Sommacal

    Awesome post, Ted! Congratulations!