Misconceptions About Venture Capitalists

A host of misconceptions abound when it comes to private equity and venture capital. Unfortunately recent history has not fared well for the finance community at large. Global recessionary trends and public money mismanagement has helped to fuel a negative stigma on anything relating to the banking and financial sector. And while certain individuals and companies do perhaps hold some responsibility for the financial ills we have, on the whole, venture firms actually add value to the economy. Here are a few misconceptions about venture capital–and a few brief rebuttals.

They Add Little Value

If you believe capitalism is just down-right bad, then you’re probably of the opinion that VCs add little (or even negative value) to society. Nothing could be further from the truth. Even some of venture capitalist methods, including leveraged buyouts, add value. Without venture capitalists we would see a great deal less money flowing into big gamble investments and new and innovative products and service offerings.

Private equity investing helps to drive innovation, creative destruction and ultimately works to increase the betterment of our lives.

They Only Pick a Few Winners

Not every firm invested in by venture capital funds wins. In fact, the aggregate returns of American VC firms have been steadily declining over the past decade. Luckily a few investments actually make it in the triple to quadruple-digit percentage return space–ultimately making up for the hundreds of loser companies that flounder and never get cash. Neal Dempsey of Bay Partners puts it this way:

There are countless misconceptions about venture capital. People outside the business often think our business involves picking a few winners early, and that this is the extent of our work. This is completely wrong. In reality, it takes five or more years for even the most successful start-ups to create value, build the team, build customer traction, and find the right opportunities that will ultimately yield maximum return before reaching a successful exit. Along the way, a startup will face critical strategic decision points that will ultimately define how successful the company will be. One cannot predict when that is going to happen. I have been involved in many startups and have had twenty-eight successful outcomes in my career. Not a single one was a simple and smooth ride. Even our most success companies have been on the verge of failure at some point in their history

The reality is that VCs pick a great deal of winners and an even greater number of losers. They play the capitalist game of balancing the risk return trade-off. In short, they play the numbers game, hoping the big wins will make up for the losses.

They’re Vultures that Will Eat Anything

While there are greedy vulture capitalists out there, the majority of them are focused on adding long-term value to their investors and shareholders. Many shareholders include pensions and public funds, which means losing has high stakes.

Unlike how many have painted venture capitalists, they actually are a bit picky about the types of meals they have for lunch. In fact, most VC funds operate under a very specific umbrella. That is some firms focus on healthcare while others are more in love with software and technology. Larger funds are of course more diversified, but the smaller funds often work under the auspices that they have their own individual expertise in doing deals–hence the focus. So, unlike some popular rhetoric, venture capitalists are not the extreme opportunists everyone makes them out to be. It could be said that they’re not vultures.

Venture Capitalists are Short-sighted

Being short-sighted in any business–and particularly venture capital–is particularly dangerous for a number of reasons:

  1. Short-sighted players cut corners. Cutting corners means business suffers. The short-sighted manager will ignore details that are so necessary for a startup to have long-term staying power. Most fund managers are OCD about the details. Details are never short-sighted.
  2. The short-sighted destroy long-term value. Of the big wins in venture capital, many of the successful companies have been acquired and remain in existence for decades.
  3. Short-sighted investors burn bridges. The existence of a VC fund–and, particular follow-on funds–means investors will need to be pleased so as to come back for more. If they’ve had consistent returns over a long period, they’ll easily get funded again. Burning bridges is bad for business. If VCs were more short-sighted, there would be a great deal more “one fund” VC firms out there.
  4. Short-sighted VCs would be more hands-off. Ask any true VC how much time he/she spends with the particular entrepreneurs in the fund’s portfolio. The hands-on nature of the process showcases a desire for both short and long-term growth and success.
So by definition, venture capital is about growth and growth should and always will be focused on long-term investing. If the venture fund is private, it is even more likely to be long term focused. Without the stringent reporting requirements by the SEC and a mass of public shareholders, management is often less focused on meeting next quarters numbers and more ready to sacrifice a few sacred cows now to eat the fatted elephant in a few years.

Some would like to think of venture capitalists as in it only for the money. Certainly profitability plays a big role in what VC firms looks to accomplish in their strategic missions. However, long term sustainability and consistent growth of the portfolio is what the businesses are all about. Misconceptions will continue to abound, but while people misunderstand, venture funds will add value a bit at a time.

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Nate Nead
Nate Nead is a licensed investment banker and Principal at Deal Capital Partners, LLC which includes InvestmentBank.com and Crowdfund.co. Nate works works with middle-market corporate clients looking to acquire, sell, divest or raise growth capital from qualified buyers and institutional investors. He is the chief evangelist of the company's growing digital investment banking platform. Reliance Worldwide Investments, LLC a member of FINRA and SIPC and registered with the SEC and MSRB. Nate resides in Seattle, Washington.
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