Venture capital is the exception, not the norm, as a funding source for even tech startups. More VC-backed new companies fail than succeed, and since 1999 US VC funds have barely broken even.
Those are just some of the myth-busting facts that were revealed by Diane Mulcahy, director of private equity at the Kauffman Foundation, the leading US entrepreneurship think-tank, and a former VC herself, in the May 2013 issue of the Harvard Business Review (HBR) that focused on entrepreneurship.
John Mullins, an associate professor at London Business School and the author of The Customer-Funded Business: Start, Finance, or Grow Your Company with Your Customers’ Cash, writes in the HBR blog this month that that more than two generations ago, the venture capital community - - VCs, business angels, incubators, and others - - convinced the entrepreneurial world that writing business plans and raising venture capital constituted the twin centerpieces of entrepreneurial endeavour. "They did so for good reasons: the sometimes astonishing returns they’ve delivered and the incredibly large and valuable companies that their ecosystem has created.
But the vast majority of successful entrepreneurs never take any venture capital."
About 76% of US tech companies acquired in 2012 had not raised institutional investment (VC/PE -private equity) prior to acquisition.
Prof Mullins says that venture capital financing may even be detrimental to a startup's health. As venture capital investor Fred Wilson of Union Square Ventures puts it, “The fact is that the amount of money startups raise in their seed and Series A rounds is inversely correlated with success. Yes, I mean that. Less money raised leads to more success. That is the data I stare at all the time.”
These are Diane Mulcahy's six VC myths:
"Myth 1: Venture Capital is the Primary Source of Startup Funding
Myth 2: VCs Take a Big Risk When They Invest in Your Company
Myth 3: Most VCs Offer Valuable Advice and Mentoring
Myth 4: VCs Generate Spectacular Returns
Myth 5: In VC, Bigger is Better
Myth 6: VCs are Innovators
VCs will continue to play a significant, but smaller, role in channeling capital to startups, Mulcahy concludes. The contracting VC industry and new funding sources now available to founders are finally "shifting the historical balance of power that has too long tilted too far toward VCs."
Prof Mullins says that seeking VC support early in the life of a startup can be a distraction and too much of the company can be given away before it establishes itself
"But the best news is this. If you raise money at a somewhat later stage of your entrepreneurial journey, you’ll find that many of the drawbacks have largely disappeared. Why? Because with customer traction in hand, you’ll be in the driver’s seat, and the queue of investors outside your door will have to compete for your deal."
He highlights that in the typical successful fund, on average only 1 or 2 in 10 of the portfolio companies - - the Googles, Facebooks, and Twitters of the world - - will actually have delivered attractive, and occasionally stunning, returns. "Facebook alone accounted for more than 35 per cent of the total VC exit value in the United States in 2012. A few more portfolio companies may have paid back the capital that was invested in them, but most of the rest are wipeouts. In the VC game the very few winners pay for the losers, so most VCs are playing a high-stakes all-or-nothing game. Are these the kind of odds with which you’d like to put your new venture into play?"
About 75% of venture capital-backed US startups do not return investors' money
About 75% of venture capital-backed US startups do not return investors' money. The common rule of thumb is that of 10 startups, only three or four fail completely. Another three or four return the original investment, and one or two produce substantial returns. However , the National Venture Capital Association estimated that 25% to 30% of venture-backed businesses fail outright.
The Wall Street Journal reported in 2012 that research by Shikhar Ghosh, a senior lecturer at Harvard Business School showed that venture capitalists "bury their dead very quietly." Ghosh adds: "They emphasize the successes but they don't talk about the failures at all."
The Journal says that of the 6,613 US-based companies initially funded by venture capital between 2006 and 2011, 84% were closely held and operating independently, 11% were acquired or made initial public offerings of stock and 4% went out of business, according to Dow Jones VentureSource. Less than 1% were in IPO registration.
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