The Death of Venture Capital as We Know It
Today's Venture Capital has been struggling for sometime with only a few small hits and very handful of big returns. The problem is that entrepreneurship is stuck because of venture capital. We need to modernize the venture capital business so entrepreneurs can get busy. I am seeing more early stage creative development then in years past. The entrepreneurial process will never die but it will evolve. These are the pains that we are seeing now with start-ups.
The capital markets are a mess and with no liquidity market today's venture capital firms are spinning their wheels. The good news is that capital markets are efficient and will work around the bottleneck we are seeing.
Investors in venture capital and private equity funds who want out are discovering that their stakes are worth less than they paid for them.
Venture Capital as practiced today is a broken model
There are plenty of people who believe the VC model is truly broken. The debate really took off when recent study on the results of Venture Capital investments into angel-backed companies concluded that
a) After a Venture Capital invests your chances of failing completely also increase significantly
b) 1000 of companies that deserve funding aren't getting it.
- VC funds financed only 167 start-ups in 2002
- Â 17.3% average return for early-stage VC funds during the 20-year
c) Venture Capital has become a lottery system
- 4% of all VC reaped over 65% of the rewards
- Â 2% are "home runs", projects with annual returns of 100%
Meanwhile, it's an important question, regardless of what you believe, because it creates debate and change. Few things ever stay the same, and the VC model is no different. And without a doubt, I believe the VC model and start-ups investment in general will undergo significant change in the next 5+ years. We're just at the early stages of it. The focus shouldn't really be on whether the venture capital model is broken, but on how venture capital is going to work in the future; because I think most people agree that change is afoot.
So what will that change look like?
And beyond venture capital, how will the entire industry and approach for raising capital evolve?
A new Venture Capital model
The changes needed in a new Venture Capital model are: "Reduced Risk, Sustainable equity fund and modernize the venture capital business so entrepreneurs can get busy" by fundamentality change Venture Capital focus and accountability. In order to accomplish these fundamental changes, VC should refocus and build they business model on the following 3 pillars.
1. Circle of Innovation with Entrepreneur seed funding
Entrepreneurs have become disillusioned with venture capital. Venture has earned, deservedly, a bad rap for being not forward looking in its approach to creating value in partnership with the entrepreneur. Venture capitalists have become short sighted ... and tend to design financing structures in a way that biases toward preferences that are not aligned with the objectives of the common shareholders.
And they can optimize certain outcomes in favor of the preferred shareholder, none of which, per se, is wrong. But from the standpoint of the entrepreneur they have figured it out.... Entrepreneurs are kind of backlashing a little bit... There is now an accountability for VCs to behave and to follow through on their commitments of being a partner of building a company. But a lot of times VCs get involved and say they have all of these strategic relationships and will make all of these introductions and then it doesn't happen. This is the universal rant of most entrepreneurs that have interacted with VCs.
The old VC model relies on their network of friends, meanwhile the new Venture Capital model needs a Circle of Innovation to reconnect them to Entrepreneurs such as Universities, Faculties and Entrepreneur communities.
There is a middle ground between angel investing and venture investing and that sweet spot is woefully underserved. Â In other words small money in + modest exit = good % return.
2. Sustainable equity fund with Experts who know how to build and sell companies.
The growing numbers of Venture Capitalist profiles have MBAs, with some corporate experience; maybe some finance experience, but very little experience building companies. Due to the lack of experience, they give up after 2nd funding round. In other terms "the blind leading the blind".
The market and Venture Capital needs profiles, who know how to build and sell companies. An expert team of proven senior entrepreneurs and leaders in they field.
3. Reduced risk with early involvement of potential buyers.
Now, the key in making Venture Capital profitable is to reduce the risk. Funds should be divided into long-term and short-term engagement and involve Venture Capital specialist, Private Equity and companies early on as potential buyers.
The capital markets are a mess and with no liquidity market today's venture capital firms are spinning their wheels. The good news is that capital markets are efficient and will work around the bottleneck we are seeing.
Investors in venture capital and private equity funds who want out are discovering that their stakes are worth less than they paid for them.
Venture Capital as practiced today is a broken model
There are plenty of people who believe the VC model is truly broken. The debate really took off when recent study on the results of Venture Capital investments into angel-backed companies concluded that
a) After a Venture Capital invests your chances of failing completely also increase significantly
b) 1000 of companies that deserve funding aren't getting it.
- VC funds financed only 167 start-ups in 2002
- Â 17.3% average return for early-stage VC funds during the 20-year
c) Venture Capital has become a lottery system
- 4% of all VC reaped over 65% of the rewards
- Â 2% are "home runs", projects with annual returns of 100%
Meanwhile, it's an important question, regardless of what you believe, because it creates debate and change. Few things ever stay the same, and the VC model is no different. And without a doubt, I believe the VC model and start-ups investment in general will undergo significant change in the next 5+ years. We're just at the early stages of it. The focus shouldn't really be on whether the venture capital model is broken, but on how venture capital is going to work in the future; because I think most people agree that change is afoot.
So what will that change look like?
And beyond venture capital, how will the entire industry and approach for raising capital evolve?
A new Venture Capital model
The changes needed in a new Venture Capital model are: "Reduced Risk, Sustainable equity fund and modernize the venture capital business so entrepreneurs can get busy" by fundamentality change Venture Capital focus and accountability. In order to accomplish these fundamental changes, VC should refocus and build they business model on the following 3 pillars.
1. Circle of Innovation with Entrepreneur seed funding
Entrepreneurs have become disillusioned with venture capital. Venture has earned, deservedly, a bad rap for being not forward looking in its approach to creating value in partnership with the entrepreneur. Venture capitalists have become short sighted ... and tend to design financing structures in a way that biases toward preferences that are not aligned with the objectives of the common shareholders.
And they can optimize certain outcomes in favor of the preferred shareholder, none of which, per se, is wrong. But from the standpoint of the entrepreneur they have figured it out.... Entrepreneurs are kind of backlashing a little bit... There is now an accountability for VCs to behave and to follow through on their commitments of being a partner of building a company. But a lot of times VCs get involved and say they have all of these strategic relationships and will make all of these introductions and then it doesn't happen. This is the universal rant of most entrepreneurs that have interacted with VCs.
The old VC model relies on their network of friends, meanwhile the new Venture Capital model needs a Circle of Innovation to reconnect them to Entrepreneurs such as Universities, Faculties and Entrepreneur communities.
There is a middle ground between angel investing and venture investing and that sweet spot is woefully underserved. Â In other words small money in + modest exit = good % return.
2. Sustainable equity fund with Experts who know how to build and sell companies.
The growing numbers of Venture Capitalist profiles have MBAs, with some corporate experience; maybe some finance experience, but very little experience building companies. Due to the lack of experience, they give up after 2nd funding round. In other terms "the blind leading the blind".
The market and Venture Capital needs profiles, who know how to build and sell companies. An expert team of proven senior entrepreneurs and leaders in they field.
3. Reduced risk with early involvement of potential buyers.
Now, the key in making Venture Capital profitable is to reduce the risk. Funds should be divided into long-term and short-term engagement and involve Venture Capital specialist, Private Equity and companies early on as potential buyers.
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