How VC firms execute their own agenda

27 Mar 2023 -

When entrepreneurs consider using venture capital (VC) to jumpstart their business, they should be aware of the risks and obligations involved. The investopedia article on this topic formulates it as follows:

A business that accepts VC support can lose creative control over its future direction. VC investors are likely to demand a large share of company equity, and they may start making demands of the company's management as well. Many VCs are only seeking to make a fast, high-return payoff and may pressure the company for a quick exit.

How does a VC firm do business?

To understand the risks involved for entrepreneurs considering outside investment, let’s take a look at how a VC firm operates. A VC firm starts with an investment round to create a fund. To attract outside fund investors, they create a prospectus in which they describe their expertise, their approach, and past funds they have raised. Typically, they target big investors like pension funds. A fund can be anything between $10M to $1B. A VC firm charges an annual management fee of 2% and 20% of the profits made on their investments.

Once the fund reaches its target investment, the VC firm starts to look for companies to invest in, typically private equity investments in companies with the potential for high growth.

What is the VC success rate?

The startup and business failure rates are surprisingly high, according to this report, typically 9 out of 10 startups fail. That means that for a fund to be successful, the one startup that doesn’t fail not only needs to return its own investment but also at least the sum of the 9 other investments and the VC firm’s fee, just to break even.

And the winner is…

Unfortunately, VC firms are not very good at predicting which companies will fail and which will survive. The statistics are clear, 9 out of 10 selections they make end up as failures. So, VC firms aim to diversify their investments and find the company in the portfolio that will be hugely successful.

The sooner they find out who is the winner and who are the losers, the better. Because that means they no longer need to invest in the losers and help the winner with extra funding for the next investment round.

Therefore, they push all of the companies forward as fast as possible to see what happens: is there any traction or not? This means that if a company accepts VC funding, they are forced to spend the money quickly on hiring, marketing, and sales, even if the product is not ready.

Who’s agenda are you executing?

When entrepreneurs accept VC funding, they are essentially executing the VC firm’s agenda, not their own. They may be forced to make decisions that are not in the best interest of their business or themselves. For example, they may have to hire employees before the product is ready or bring out a product that’s only partially developed. They may also have to work with the VC firm’s contacts, even if it’s not the right fit for their business.

My advice to entrepreneurs is to spend their money wisely and focus on their own agenda to minimize risk and increase the chances of success. While there is still a high chance of failure, it’s better to execute your own agenda and focus on the essence of your business. By doing so, entrepreneurs can make decisions that are in the best long-term interest of their business and themselves, rather than being forced to execute someone else’s agenda.

What if you still want to go the VC route?

One startling statistic to conclude this post is that of all startups that submitted an application to Andreesen-Horowitz to get VC funding only 0.7% succeeded. Combined with the expected success rate of all investments, that means that only 1 out of 2.000 companies succeed.

If you ask me…

Venture capital can be a viable source of funding for some entrepreneurs (like Uber or Airbnb when they needed capital to roll out to multiple cities at once). It’s important to understand the risks and obligations involved. From my personal experience, I would advise against spending time and effort chasing VCs. The process can be arduous, and the chances of success are very low.

Even if a VC firm does invest in your business, it’s important to remember that they have their and not your interests at heart. Instead, focus on building a strong business and, if necessary, seek funding from alternative sources that align with your goals and values. By doing so, you can maintain control of your business and make decisions that are in your best long-term interest.

EDIT (9-Jul-2024)

Somebody suggested a great YouTube fragment from Simon Sinek illustrating this post.