VCs Are Not Evil: What Entrepreneurs Need To Know

1/25/10

Venture capitalists are not evil. That is the message that Bill Bryant, the prominent Seattle venture capitalist and venture partner at Draper Fisher Jurvetson, had for Seattle technology entrepreneurs earlier this month at the STS (Seattle Tech Startups) meeting. In recent years VCs have been vilified as “vulture capitalists” among tech entrepreneurs for demanding ridiculous exits for the money they invest and forcing entrepreneurs to make “bad” decisions in pursuit of extravagant pay days when more reasonable paths to modest successes, that would assure personal wealth for entrepreneurs, exist. Speaking earlier, Chris DeVore, co-founder of Seattle-based Founder’s Co-op, referred to this phenomenon as a “terminal misalignment of interests” between venture capitalists and entrepreneurs.

Bryant explained that this is primarily because VCs are bad at picking winners. “Entrepreneurs need to understand that we are bad at picking out the winners a priori. Despite doing extensive diligence that leads to the conclusion that every investment we eventually make is going to succeed—otherwise we wouldn’t make the investment to begin with—for every 10 deals we do, we lose all of our money on 5 to 6, we make a modest multiple on 2 or 3, but we make a lot of money on 1 or 2.” Those two successes need to deliver at least a 10x return to compensate for all the losers.

“Unfortunately I have to penalize the winners because of all the losers—we basically price them all the same at the start since we don’t really know which one will end up in the winner category. I don’t plan for this. I make every investment fully believing that it will be a winner, otherwise I would not invest, but the reality is 5 to 6 out of every 10 will lose all the money we invest,” he reiterated. “When an entrepreneur tells me they are trying to raise $2 million for 15 percent of their company, the way I translate that request is that I now need to believe they have a reasonable chance of reaching at least a $90-$100 million exit, otherwise it doesn’t pencil out.”

For those who think this is unreasonable, he had these words of sage advice: “Investors and VCs come in all shapes and sizes. There are about 1,700 funds. Find one who makes sense for you. There are a lot of fantastic businesses that will never reach $100 million in revenue. They are just not for us. We simply do not have the time or resources to manage two thousand, half-a-million-dollar deals.” DFJ has about $5.5 billion under management across 20 funds; the typical DFJ investment target per deal is about $12-$15 million.

Entrepreneurs should realize that VCs have investors too and must produce results. VCs raise money from institutional investors such as pensions, foundations, and endowments for whom the VC investment is just a tiny part of their portfolio. “We are to these very large institutional investors what art collections, luxury boats, and sports teams are to super high-net-worth individuals,” said Bryant. “We need to produce competitive returns to maintain our place in the asset allocation of these investors.”

Unlike many Seattle tech events where you have a panel of experts who are all in agreement, this was a night of conflicting opinions. The main topic was predicting technology trends for 2010 and areas that entrepreneurs should pursue. One of the speakers, executive coach Michael Schutzler, painted a rosy picture of the future for entrepreneurs, citing the great exits that took place in Q4 of 2009 after a lackluster year—Amazon acquiring Zappos, HP acquiring EDS, and the pending Oracle-Sun Deal, to name a few. In addition, as of December 31, 2009, 92 S-1 forms (the document normally filed before an initial public offering) had been filed. In contrast there were only 6 and 11 technology IPOs in 2008 and 2009 respectively, whereas there are usually 60-80 in any given year. It was notable that none of the S-1s filed were by Facebook, Twitter, or Zynga, companies that have been rumored to be preparing to go public. As of January 4th, many of Schutzler’s clients have suddenly started hearing from VCs who would not take their calls the whole of last year. “These guys are getting desperate to invest and put their money to work” he observed.

Bryant disagreed and did not mince words. “Exits suck!” he said with finality. He thinks the near-term exit future is bleak for both entrepreneurs and VCs, noting that statistically, IPOs are at levels last seen in 1995 while M&A is down some 50 percent. He provided some data that in 2008, the last full year of data, there were approximately 125 companies that had material exits, while 950 companies … Next Page »

Jasper Kuria is one of the founders of Meosic (widgets for social e-commerce). He was previously a product manager at Xenocode and a software design engineer at Microsoft. Follow @

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  • http://founderscoop.com Chris DeVore

    Thanks for the analysis, Jasper. Another issue worth noting is that “VC” is not a monolithic asset class – there is huge variation in fund size and investment approach across the industry, and it does entrepreneurs and VCs a disservice to treat the industry in bulk. There definitely are “VC” firms that are better aligned with early stage web companies, but they aren’t (currently) the household names in the business.

    I have a related blog post up for anyone who wants to drill into this: http://crashdev.blogspot.com/2010/01/vc-is-dead-long-live-vc.html

  • http://imedexchange.com Bob Crimmins

    Interesting piece but I must say that, rather than showing that VCs are not really evil, I think Mr. Bryant has only offered an explanation of why (some) VCs behave in an evil manner toward entrepreneurs. If it is a feature of some VCs models that they must hit an out-of-the-park home run one out of ten times and this is just not in alignment with the interests of the other 9… especially given how notoriously poor VCs are at picking the right pitch to swing at.

  • Krassen Dimitrov

    Shorter Bill Bryant:
    “we are not evil, we are just stupid”

    which is a paraphrase of Hanlon’s Razor:

    “Never attribute to malice that which can be adequately explained by stupidity.”

    Of course, anyone with a little bit of brain could have picked which investments by DFJ had a chance and which would bomb out. In the case of GreenFuel Technologies, I sent my study to all their partners in 2007, yet they continued pouring money into it, until May of 2009, when it went bust…

  • Blue Swan

    VC firms were part of the 90s/00s bubble where a rising stock market was confused with accurate picks.

    Having been around the industry, the process of applying for and getting VC funding still remains obscure and arcane. My guess is that in 90 percent of cases, its simply insiders loaning each other money to put out something they can prop up to the small investors.

    VC will have to be far more open and accessible to be part of the 21st century economy. The farmer in the field, or homemaker in the kitchen may have as valid a business idea as the cubicle worker who wants to make yet another Outlook plugin.

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