Whenever we think of innovation and startups, the first image that comes to our mind is regarding the idea, the innovation related to it, the potential market and finally the startup capital. While angel investors are very tough to come by,. most startup and entrepreneurs rely on venture capitalists.
Bob Zider mentions the six myths regarding VCs that most people have namely
1. VC is the primary source of startup funding - no there are others too, angel funding, crowd funding etc. Recently in a case that involved finding costs to finance medical treatment for a 1 year old kid in Kerala India, an amount of 18 crores, almost $3 million was raised by crowd funding in a matter of 6 days.
2. VCs take big risks with startups - actually with the hefty 2% fee they charge on their funding to the startups, they are much better off. often the owners of the VC fund may put up less than 2% of the total corpus. In effect, the risk by the VCs is very less. They cover their risk well.
3. VCs offer great advice and mentoring - the opinion here differs. There are a group saying that VCs do offer great advice with their vast experience while an equal percentage says that they are not helpful. However VCs considering their vast exposure and experience, everyone agrees, VCs are potential sources to offer great mentoring and advice to the startups.
4. VCs generate spectacular returns - Kaufmann's Foundations has invested in about 100 startups over the past 20 years (as reported in the HBR study referred below) and returns from 20 of them have been barely 2-3%, while 60 in this 100 actually failed in generating promised returns.
5. In VC, the bigger, the better - What has been observed in VC funding over the years is that when the VC funding becomes large and exceeds $250 million, the VC performance is hit. The valuable lesson from the HBR study given below is that startups that require funding in excess of $250 million, do not give enough returns.
6. VCs are Innovators - this is totally wrong, the VC funding scenario has not changed over the past 20 years, devoid of innovation. Funds are structured, capital raised and partners paid just like it was done 2 decades back.
Click here to read an interesting article from HBR Dec '98 by Bob Zider, titled How venture capital works ?
Click here for a more recent article in HBR May '13 by Diane Mulcahy titled Six myths about venture capitalists, which made interesting reading.
In one of my discussions with startup founders, I was told the golden rule, start small, scale fast. Execution is the key ..
For example, Amazon which was started in 1994, in 1995 received $8 million in venture funding from Kleiner, Parkins VC. By 1999, this $8 million generated returns of more than 55,000 %. (click here for the Amazon startup story from www.fundable.com). These are exceptional stories. More often than not from general experience, the HBR study says that only about 20% of VC funding entities are able to generate returns of more than 2-4% required to pay off the VC funds.
These days Amazon has set up a $250 million Alexa VC fund to finance potential improvements and innovations to its AI assisted smart speaker echo, which is quite focused and giving pointed returns.
Finally the four mantras for startup success, outside the VC impact are as below (click here)
1. stay focused on your differentiators
2. stay hungry
3. stay humble and
4. sty frugal
Very valid advice to all the budding entrepreneurs out there waiting to convert their startups to the top unicorns of the world.
George.
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