Monday, May 20, 2013

6 Myths on Venture Capitalists

An article worthwhile reading for both entrepreneurs, venture capitalists (VCs) and corporate finance specialists is "6 Myths about Venture Capitalists" by Diane Mulcahy (HBR, May 2013). According to Ms. Mulcahy, a former VC and now director of private equity at the Ewing Marion Kaufman Foundation, entrepreneurs often feel "as if they are in the back seat" when dealing with VCs. This is caused by a number of misconceptions or myths about VCs and what they are offering:

1. Venture Capital is the Primary Source of Start-up Funding - In reality, especially for smaller new businesses, 'angel investors' (affluent individuals who invest smaller amounts of capital in earlier stages, for example see Angelist) funds more than 16 times as many companies as VCs do. Also 'crowdfunding' (very small online investors, for example see kickstarter) is growing quickly.
2. VCs Take a Big Risk When They Invest in Your Start-up - In reality, they do take a lot of risk, but not with their own capital, but with capital they received from associated investors. On thus committed capital, VCs typically charge an annual 2% fee, plus a success bonus.
3. Most VCs Offer Great Advice and Mentoring - In reality the level and quality of advice given varies tremendously. Entrepreneurs are well-advised to do some thorough due diligence before they sign up.
4. VCs Generate Spectacular Returns - Some do, some don't. Overall as a group they don't perform better than the markets.
5. In VC, Bigger is Better - In reality, the smaller funds tend to outperform the bigger ones.
6. VCs are Innovators - The VC industry has not been very innovative over the last decades, new initiatives such as mentioned Angelist came from outsiders.