Empathy for VCs
The challenges endured by venture capitalists are similar to those experienced by entrepreneurs, only more secretly and more severely. Acknowledge it and do something about it.
Sébastien, a good friend of mine in Paris who works in the hedge fund industry, had these surprising words to say during our last chat: “I feel sorry for venture capitalists (VCs) because they are too often deceived by tech-entrepreneurs and even ripped off with wrong valuations.” Hearing this, I realized that most of my friends who work in the financial markets (as traders and asset managers) think the same way. The VC business seems cool—or at least less boring than traditional finance—but there is a price for it: a lack of transparency, very long-term maturity, no liquidity, strong human and emotional bias, high risk (near gambling), and low return on average. In the realm of traditional finance, venture capital as an asset class sucks.
This position stands in contrast to the lovely media stories we read every day in which VCs like celebrating their “partnerships with” (read “investments in”) tech companies or telling about their entrepreneurial journeys (read “nice exits”). Making us believe we live in a wonderland orchestrated by a few white knights is part of the enchantment. And it works: Observers see VCs as visionary leaders, agents of change, and gold makers; states welcome them; bankers, lawyers, and other consultants seek their favors; talent wants to work for them; and (obviously) tech founders try to "get a dance" with them.
The reality is less glamorous.
The top quartile and the rest
According to the Kauffman Foundation report (2012), “only a small number of funds generate big VC return.” By “small number,” they mean 25% of VC funds; that is the top quartile.
This number is consistent with another chart extracted from a recent Swisscom Ventures presentation. Only VCs in the top quartile are likely to be profitable; among them, only an elite few hit big numbers.
According to Morgan Stanley, August 2020, “returns for venture capital funds, and to a lesser degree buyout funds, are skewed. You earn returns much higher than the median if you are invested with funds in the top quintile (i.e. top 20%).”
Some estimations are even worse. Tomer Dean, contributor at TechCrunch, states: “Ninety-five percent of VCs aren’t actually returning enough money to justify the risk, fees and illiquidity their investors (LPs) are taking on by investing in their funds” (post). According to many sources (here and here), this is higher than the failure rate of start-ups, which is estimated to be around 90%.
Even that is only for professional VC firms that know what they are doing. Imagine what it is like for business angels who invest at an earlier and riskier stage, without the same level of awareness, knowledge, experience, or networking.
Nic Brisbourne, the managing partner at Forward Partners, wrote on The Equity Kicker: “Lots of people start investing, lose their shirts, and then wish they had done something else with their money. I’ve seen that happen to angels, entrepreneurs, and corporate VCs. Some people investing on AngelList lost everything 2 years only after their investment. The loss is quicker than the gain.”
Real challenges, proxy experience
Like entrepreneurs, VCs must conduct fundraising events, hustle to access deal flow, and struggle to solve critical problems. The process is similar, but the experience is different. Entrepreneurs thrive by creating meaning out of nothing; they can rely on teamwork and community support, and they continuously develop operational and transferable skills. If they fail, they receive support and a second chance. If they succeed, they gain a sense of personal achievement on top of the financial reward. Venture capitalists only get a piece of that and sweat the same or more.
Before investing, VCs, also called general partners (GPs), raise funds from other investors—limited partners (LPs). To get their attention, GPs must show a credible track record of previous performance. Without it, the likelihood of raising enough capital is very low. Given the usual management fee of 2%, GPs must raise at least USD 40 million to cover a small team's operating costs. Those with an outstanding track record can raise 10 or 20 times more. To raise such large amounts, most GPs conduct a roadshow for months, trying to access the proper decision-makers among LPs. These people are secretive, out of sight, busy, and mainly focused on the top-quartile segment. In case they are interested, LPs impose many constraints on GPs (financial commitment, timing, quotas, thresholds, etc.) and will rule them out if the performance falls below their expectations.
Once they have raised their funds, VCs hustle to access a good deal flow and pick the very best investment opportunities. According to Marc Andreessen, cofounder of Andreessen Horowitz, “to succeed in venture capital, you must be one of the top five firms. And to get there, you must have an amazing deal flow” (source : Why do VC firms become Platforms? by Louis Coppey, VC at Point Nine). It is a zero-sum game: Good investment opportunities are scarce, and VCs compete fiercely to secure them. When too much “dumb money” is in the market (because of low-interest rates, for example), valuations can become very high and seriously erode the overall return.
Post-investment, VCs must do whatever they can to help their portfolio companies grow. And it is far from a vacation. Charlie O'Donnell, founder of Brooklyn Bridge Ventures, describes it well:
Ever watch an animal get hit by a car and limp around afterwards? That's kind of like what it's like being on board with these companies after you make an early stage investment. They're all dealing with super limited resources and they'll never be able to move as fast as you'd like them to--and there's no laying on of the hands that you can do to make it all better. You just have to hope they regain their footing slowly and get on their way. You can try and alert them to other traffic, slow it down, ease pain by being calm and present, but ultimately, it's up to them to get stronger and stronger with every step and continue on down the road. Even the best and most active board members can still feel pretty helpless. Extract from Why being a VC sucks. Advice to anyone who wants to get into venture capital.
Fear & loneliness
According to Gigi Levy-Weiss, General Partner at NFX, VCs have two main psychological drivers:
“FOMO: Fear of missing out - The deals that got away come with deep personal regret… when a VC partner sees a company which could be huge – with a great team, in a field they like and a good idea – it’s tough not to invest.
FOLS: Fear of looking stupid - VCs don’t want to invest anywhere where they can end up looking stupid. “How did you invest in an Uber competitor after Uber already raised $5BN?” is not a question you want your LPs to ask you.”
VCs have fears indeed and not so much support to deal with them.
Alex Niehenke, Partner at Scale Venture Partners explains in this interview that although it is a great job, “it’s much less team-oriented than a lot of other things, it can be quite lonely. Specifically, if you think about the job as an hourglass, it’s really lonely on the front end, and it’s really lonely on the back end, and there’s this piece in the middle where you collaborate.”
This story published by The Economic Times relates how it’s hard to be a Venture Capitalist and even tougher to be his wife. “When a startup shuts down (…), everyone sympathises with the entrepreneur. Which is fair - he lost his company. What's amusing is how no one thinks of the VC who lost all his money and got nothing in return except a certificate of “You don't know how to make a good investment”.”
In his essay A Unified Theory of VC suckage, Paul Graham, founder of the start-up accelerator Y Combinator, explains why VCs are arrogant and why many stakeholders dislike them, including other VCs: “They were the most arrogant people I've met in my life. And I've met a lot of arrogant people. I'm not alone in feeling this way, of course. Even a VC friend of mine dislikes VCs.” According to Graham, it has something to do with the VC funding model itself which forces each individual partner to invest a lot in each company: “with so much at stake, they have to be paranoid … they have to be devious.”
This article is not about commiseration and is certainly not about being condescending. It is an attempt to understand what is behind the curtain, open up the human, vulnerable side of investors, and develop empathy for them, including the mighty ones who are keen to flex their muscles.
With empathy, you can change little things in your behaviors and transform your relationships with investors.
Here are a few suggestions:
Before meeting with a VC: Develop a deep understanding of their investment thesis, investment criteria (the visible and hidden ones), investment process, philosophy, successes, and failures. Don't pay too much attention to their marketing; be scientific about your research, and prepare well to facilitate an evaluation.
During the discussion phase: Try to manage their fear by showing that you are a master of the return/risk rationale. VCs must feel that you are transparent, that you play fair, and that they will look good by investing in your company. If they don't respond to your emails or return your call, don't take it personally, and do not judge them; stay professional.
In case a VC says no: Follow this advice from Brad Feld, co-founder of Foundry Group: “Trying to push past the no is usually pretty ineffective. Instead, recognize that they're saying no to investing in your company now. In the future, depending on what progress you make, many VCs are willing to revisit your company and potentially invest in the company downstream (Linkedin).”
In case a VC says yes: Set yourself the goal of getting to know them better, and develop your listening skills. You can also try to help them in their endeavor by promoting their investment thesis, showing gratitude for their good actions, locating promising investment opportunities, making qualified connections, and sharing your technical expertise.
Please do it for them, not for yourself, and see what happens.