Common Myths of US Venture Capital
Myth #1: In America anyone with a big idea
and an experienced management team has access to tons of capital.
It all depends on finding a partner in a venture capital firm who understands
the opportunity and your solution, and who believes in you as an entrepreneur.
Hence the tendency is to pick an idea and package a business so it “sells” to a
large number of partners; however, if the idea is too popular, too many firms
will already have that slot filled in their portfolios. And with the big guys, a
pre-existing relationship and/or killer management team is required.
It is true, of course, that the American tendency to over-build guarantees that with a big firm over-spending is de riguer. They have to pay all those fat salaries for a start, but the real reason has to do with minimum investment levels, which in turn has to do with size of fund. Due to these factors, all sorts of funny things happen (fully explained in my “Venture Capital Review”)!
Myth #2: American VC’s have operational backgrounds and are therefore more suited to helping entrepreneurs.
Some partners in American firms have operational backgrounds. Some don’t. But regardless of this, they almost always don’t have the time or expertise to devote more than cursory attention to a given venture. The life of a VC is one of flying from one board meeting to the next. The larger the portfolio, the less attention that can be devoted to any one venture. In addition, because of various factors in the dynamic between a management team and its investors, the relationship can be adversarial, turning board meetings into a game of hide and seek, not show and tell.
American firms diversify their portfolio and play a numbers game, so in addition to the factors just mentioned, the expertise of any partner will have less likelihood of applying to a particular venture, aside from general business wisdom and knowing about comparable ventures. It is more comforting and it can be helpful to have an experienced businessperson on the board, but in practice that may not make much difference when the substance of operating a business is remote to that person.
Myth #3: Venture capital is risk capital – therefore, the risk premium of taking large portions of a company is justified.
Americans believe in the principle of a smaller portion of a bigger pie. But that’s because a) a bigger pie is possible and b) someone else will eat your pie if you don’t dominate it. Oddly, this principle can translate into more cooperation – enthusiastic partnering, openness to better talent, working with others toward a greater goal (as opposed to the greater good!). In terms of venture capital, though, the principle doesn’t always apply.
American venture capital has steadily removed risk from the profile of its portfolios. Before the dotcom boom, there was talk that success rates had gone from 1 in 10 to 1 in 6. How was that achieved? By removing risk, of course! Companies had to be fairly developed to attract serious funding (and providing, of course, they were suitable for venture funding). Then the dotcom craze allowed all kinds of risk to sneak in, and now risk is definitely out of the picture. So where does that leave the risk premium? At the end of the day, venture capital has become practically indistinguishable from private equity in terms of relevance to start-ups.
Myth #4: Founders are not the people to take a company forward; execution requires new management.
This one is true, but a myth, at least in part! It’s worth mentioning because the viewpoint is so prevalent that it deserves further commentary, and there is a contrary viewpoint that seems more common in Britain. The key issue is scale. In America, stepping up to national scope is a challenge, and competition can be so intense that execution is critical. There are legions of highly experienced managers and it usually does make sense to get them on the management team – in fact, as mentioned above, larger VC’s consider that a basic requirement. In Britain, a smaller scale is sometimes acceptable.
There is also a difference between management and leadership. Start-ups are like religions; the team has to have faith (a different version of this dynamic applies to established companies as well). Founders symbolize that faith and the best ones can keep teams motivated in the face of extreme hardship. When the going gets tough, the founders persevere and stand like anchors to keep the flock from running off. The argument goes that founders usually lack professional management skills, but those skills can be brought in. Symbolic leadership is not so easy to bring in. If a founder doesn’t realize his or her own limitations, then that’s a problem – but why as a matter of principle should VC’s throw the baby out with the bathwater?
So who am I? An experienced entrepreneur who experienced firsthand the growth of Silicon Valley from 1986 to 2002, and a survivor of several booms and busts. I am available to mentor or manage UK companies and I have written a venture capital critique, with a proposed solution, that I would be happy to send you free. Just ask.
At your service,
Phil Inje Chang
Practical Innovation and Change
Management, Markets and Mentoring for Growth
0207 482 5244
07799 660 435
© Phil Inje Chang, 2005. All rights reserved worldwide.