Not a Fan of Venture Capitalist

While I am a fan of venture capital, I don’t think much of Venture Capitalists.  This may sound strange from the person that was a co-founder of what was one of the largest and most successful venture capital organizations – Intel Capital. 

I never thought of myself as a venture capitalist.  Rather, I considered myself as an Activist Strategist.  Investing in early stage companies was a means and not the end.  The return on investment was a great benefit but growing and expanding Intel’s business was the objective.  Recently, Intel announced that it was selling off a large portion of its portfolio because their current investments were not considered strategic.  I think they are making the correct choice. 

In my role as Vice President of Business Development and leader of the largest segment of Intel Capital, I often dealt with the venture capital industry and, in particular, many of the most prominent VC firms.  Frankly, I did not find them very strategic. Of course, there were exceptions, and some VCs were very smart, creative and even nice. Most prominent in this group was Jim Breyer, who led Accel. 

Do VC’s Add Value in Addition to Capital

For many years, I have pondered the question of whether VCs add value in addition to money or perhaps could they have the opposite effect.  There is no good way to answer this question. I don’t know what kind of experiment would provide the proof one way or the other.  So I have to go on my intuition and my knowledge of venture capital.  I am about to make some enemies, but frankly, my opinions no longer have an impact, and most of the today’s VCs don’t even know who I am. 

In previous posts, I have tried to explain that the VCs are not aligned with the entrepreneur, although they love to give that impression. Now I want to take on the question of whether they provide added value. 

Passing the ten times test

Imagine that you are starting a new company and you need to raise money from VCs.  To get funded, they will have to think that your business has a potential to make a significant return to the investors.  In general, they will be looking at the expected value.  That means that if the there is a 10% chance that the company will return 200 times the investment, then the expected value is 20 times the investment. It is a bit more complicated than that because we also have to take into consideration to the time to get that return.  Most VCs are looking for investments that will realize a minimum of 10 times their investment. They hope that at least 20% of their investment have this kind of return.  Then they hope that they will, at least, get their money back on another 50% of investments. However, this does not mean that the founders of those new companies got a cent. 

Based on this, they define “Investable” as companies that have the potential to return more than ten times the investment.  There is a good chance that if the company’s plan does not convince the VCs that this potential exists, they will not invest.

Four Quadrant Model (Only one winner)

Most early stage companies are not worthy of investment.  For instance, the idea may not be compelling, and/or the team may not be strong enough.  So it makes sense that a good portion of the companies seeking to fund will be in the quadrant “Not investable” and “Not a Good business”.  Notice I am separating the two concepts.  Then there the companies that are “Investable” and are a “Good Business”.  There are also businesses that are “Not investable” but are a “Good Business”.  If they are not able to get funding, those companies will not happen.  Lastly, we have companies that are “Investable” but not a “Good Business”.  They will end up failing or, at least, doing poorly and will certainly not give a return on effort to the founders. 

There are many of ways that a business can get funded but end up failing

The company could start out with a bad business and have bad execution, but a VC still invested. This situation just results from a poor selection by the VC and is not that unusual.

However, I think many of the companies that fail, start out as a “Not Investable” but “Good Business”, but in the process of getting funded, the VC influenced the business strategy in a way that reduces instead of improves the probably of success.  I know this is a strange concept that I am sure many will disagree with, but what I am saying is that most VCs are bad at doing their jobs. 

As an entrepreneur, the only quadrant to be in, is clearly a company that has been a  “Good Business” and “Investable” therefore, will successful.  That is the only quadrant with a payoff.  The next best two quadrants are the two where there is no funding provided. In this case, the founders get to do something else with their lives.  The worst place is to be is in the quadrant where funding is secured, but the company fails. In this case,  the many years of hard work by the founders results in no payoff.