Debunking The Top 6 Myths About Venture Capitalists
Once you get past the stories of companies like Apple and Google you’ll find numbers that show many more venture backed startups are failing rather than succeeding.
On an average, since 1999, venture capital funds have barely broken even.
The industry wouldn’t exist without entrepreneurs but most people looking to start a company are intimidated by venture capitalists.
Here we’ll look at some of the common myths surrounding venture capitalists so hopeful entrepreneurs can get a more realistic view of the industry and what it has to offer.
Myth 1: Most Start-Ups Are Funded By Venture Capitalists
Less than 1% of U.S. based companies have raised money from venture capitalists.
The industry peaked in the late 1990s and since then the number of active venture capital firms has fallen drastically from 744 (in 2001) to 526 (in 2011).
Additionally, the amount of venture capital raised was greatly reduced, from $39 billion in 2001 to under $19 billion in 2011.
Just because venture capital funds have diminished that does not mean that there is less money for start-ups.
Different types of financing are emerging and giving entrepreneurs different ways to raise the necessary capital.
Entrepreneurs are starting to lean on angel investors and crowdfunding to support their businesses.
Angel investors fund 16 times as many companies as venture capitalists do and that number is continuing to increase.
An angel investor is a wealthy person who invests a smaller amount of money at an earlier stage of the company than venture capitalists do.
In 2011 angel investors were responsible for investing in 65,000 companies, giving out $22 billion.
Just for comparison, in 2011 venture capitalists only invested in 3,700 companies, but giving out $28 billion.
Crowdfunding gives entrepreneurs the opportunity to raise capital from a mass amount of people.
Instead of gaining equity like venture capitalists, the people who invest receive things like products from the new company.
Crowdfunding websites like Kickstarter are gaining traction; in 2012 they reported that 18,000 projects raised almost $320 million through their site.
Note that this is 3x the amount that was raised in 2011, so crowdfunding is becoming even more popular every year.
Myth 2: Venture Capitalists Are Risk Takers
SharkTank gives viewers the perception that venture capitalists are big risk takers who will back up your new ideas.
Most venture capitalists are not taking risks with their own money but rather their investors’ capital.
In a typical venture capital firm the partner’s money only accounts for about 1% of the total.
Entrepreneurs put everything they have into their businesses with no safety net to fall back on.
It’s the complete opposite for a venture capitalist.
Most of a typical venture capitalist’s compensation comes from fees so they’ll get these no matter how badly you fail.
Venture capitalists take far fewer risks than the average entrepreneur who puts everything on the line for their idea.
Myth 3: Venture Capitalists Give Great Advice and Will Mentor You
In exchange for a higher amount of equity at a lower valuation of your company a venture capitalist will often tell you that they also offer experience, expertise and connections that will make the deal worth it for you.
Be wary of this, venture capital firms are all different and many won’t put any effort into aiding you in a non-financial way.
If a venture capitalist offers you a deal like this do your due diligence to research and confirm that this is in fact true.
Myth 4: Venture Capitalist Means A Great Return
Getting the help of a venture capitalist does not mean your business is destined to succeed.
Since the 1990’s venture capital funds have not really beaten the public markets, and venture capitalists have gotten less money back than they’ve invested since 1997.
There are some venture capital firms that do get great returns but the average fund breaks even or loses money.
While most people think venture capital investments are high risk with high rewards, it may surprise you that venture capitalists hardly ever get a high return even though they take on the high fees and risks.
Myth 5: Bigger Deals Are Better Deals
When the internet boom peaked in 2000 venture capital began growing rapidly.
All of a sudden there were over 1,000 firms that had given out a total of $220 billion.
So what happened?
We all realized that venture capital doesn’t scale well.
Money flooded in and returns started to fall.
Venture capital has not recovered from that yet and the number of firms and amount of capital being invested have both declined since 2000.
Myth 6: Venture Capitalists Are Innovative
Nothing innovative has happened in the field of venture capital for over 20 years; they continue to fund businesses the same way they always have.
Innovation in start-up financing is only happening outside of the venture capital world with crowdfunding.
The fact that there are now more ways for entrepreneurs to finance their businesses should give them some confidence when speaking with a venture capitalist.
They do not need to rely on them for funding, which finally puts the entrepreneur in a good position to negotiate a better deal for themselves.