At the outset (before sharing some of my thoughts on the topic), let me make it clear that I have been (and still am) an angel investor, LP in VC funds, and have also set up angel groups! I have won and lost in this investment class. The experience has taught me a thing or two. By no means am I an expert. I realize there is a lot of research, and literature but that doesn’t stop me from sharing my perspective.
First of all what’s the foundational basis for venture capital and venture investments ? To stimulate serious innovation, disrupt industries, generate outsize returns, to create massive wealth, right ? Isn’t that what happened with HP, Microsoft, and Google ? (BTW, how many rounds did they raise – 1,2 ? Series A,B maybe ? As opposed to today’s Series X,Y 😂 ?.. But that’s a different topic. We will get to that later). Venture capital and ventures they fund are supposed to change the world like the HPs did.
The problem in today’s venture scenario is too much capital chasing too few good deals. Capital is available in plenty. Funds are under pressure to produce returns for the first-rounders. Founders are under pressure to raise, raise and raise to the extent that raising becomes the primary focus and not product. They have long forgotten what the original thesis even was. Sounds like a bubble ? There’s even a theory that venture capital is a ponzi scheme. That may be an extreme viewpoint but does make you stop and think. Since it is fashionable and sexy as an investment class, a lot of the new abundance of wealth that has been generated recently has gone into formation of new funds, angel groups and the like. The dirty little secret of the VC industry and by corollary angel groups and investment clubs is that most of these don’t even return capital let alone generate decent returns (upwards of 20-25%). And if it doesn’t return at that level, it wouldn’t make sense, purely from an investment standpoint would it? There are any number of solid, less risky investment classes to consider, such as real estate.
Very few VCs have cracked the code – the top tier ones that had few early successes, built brand equity and to which the good deals flock. Then there are some boutiques that have a particular thesis or an affiliation that provides some assurance of steady deal flow volume and quality. The rest are struggling to get capital back and often failing, let alone changing the world!
A legendary entrepreneur and VC once explained the VC math in very simple terms. A $100 M fund, is left with $80M which has to return $600 M for a 5X return (assuming the standard 2/20 model). However, assuming half the ventures fail (very reasonable), then $40 M has to return $600 M – which is 15X. If there are 10 deals each with deployed capital of $4M each, each of them has to return 15X . What are the odds ? Equally rare, though a more likely occurrence, is one deal would return 150X and when that happens you have a winner. And once in a while when you get a 1500X , you have a Sequoia or a a16z or a KPCB in the making. These things don’t happen often which is why most funds struggle.
Which brings me to the most important point. If we look at the history of venture, the big hits came from left field – they defy logic. Due diligence didn’t make Google happen. Logical analysis didn’t get Microsoft started. TAM and SAM studies didn’t create Nvidia or Tesla. These are all creations of crazy brainiacs and investors that saw something special that others didn’t – not with math, analysis and logic but something else – ‘gut feel’. And with emotion! Another legendary entrepreneur turned investor (Ram Sriram) is supposed to have nervously written a $100K check to Larry and Sergei sans analysis and the rest as they say, is history.
As for me, I am writing those checks nervously off and on, based on gut-feel but at heart, I remain a builder first ! And wholeheartedly support fellow bootstrap founders!
Ram..