How Venture Capital Works

Posted in Recommend Reading

Of course there have been changes in how VC is deployed (& in tech) over the past couple of decades, though I still managed to find some interesting tidbits from an HBR article on Venture Capital written around the first Internet boom/bust – in 1998:

  1. Contrary to popular perception, venture capital plays only a minor role in funding basic innovation. Venture capitalists invested more than $10 billion in 1997, but only 6%, or $600 million, went to startups. Moreover, we estimate that less than $1 billion of the total venture-capital pool went to R&D.
  2. The myth is that venture capitalists invest in good people and good ideas. The reality is that they invest in good industries.
  3. In return for financing one to two years of a company’s start-up, venture capitalists expect a ten times return of capital over five years. Combined with the preferred position, this is very high-cost capital: a loan with a 58% annual compound interest rate that cannot be prepaid. But that rate is necessary to deliver average fund returns above 20%.
  4. Assuming that each partner has a typical portfolio of ten companies and a 2,000-hour work year, the amount of time spent on each company with each activity is relatively small. If the total time spent with portfolio companies serving as directors and acting as consultants is 40%, then partners spend 800 hours per year with portfolio companies. That allows only 80 hours per year per company—less than 2 hours per week.
  5. Ultimately, the entrepreneur needs to show the venture capitalist that his team and idea fit into the VC’s current focus and that his equity participation and management skills will make the VC’s job easier and the returns higher.

via How Venture Capital Works.