Why 99.997% Of Entrepreneurs May Want To Postpone Or Avoid VC -- Even If You Can Get It

In a previous blog, I had commented that most of you will never get VC (from a VC limited partnership). But some of you may still have hopes. So for you, the key question is whether you should accept VC if you get an offer from a VC fund. Firstly, remember that securing VC does not mean that you have built a home run or have become wealthy. All it means is that you may have just ceded control of your business to investors whose interests may not coincide with yours. VCs want high returns, which may come at your expense. Secondly, even with VC, you may not make a fortune, but you may have lost control of your one great idea (not many get two, and most of us do not even get one). Most entrepreneurs I met in the course of my financing career had faith that their business would succeed, and that they would make a fortune. Otherwise why become an entrepreneur and suffer the agonies of building a new venture? For many, it is to build a home run. Successful Entrepreneurship Is Not About Winning A Popularity Contest With Venture Capitalists Capital Flows Capital Flows Contributor Why 99.95% Of Entrepreneurs Should Stop Wasting Time Seeking Venture Capital Dileep Rao Dileep Rao Contributor 3 Reasons Entrepreneurs Shouldn't Focus on Venture Capital Brian Hamilton Brian Hamilton Contributor 'True Grit': What It Takes To Succeed As An Entrepreneur Cheryl Conner Cheryl Conner Contributor Home runs are the holy-grail for entrepreneurs and for VCs – the stuff that dreams are made of. If you can develop one of these, not only are you likely to be fabulously wealthy, but journalists will endlessly write your story and everyone will seek your opinion even on topics you are not familiar with in hopes of getting an investment in their venture or a grant from your foundation. These are the deals that can get your name in lights. You will be feted and hailed as a genius, until of course, your stock tanks. Home runs are ventures like eBay, where a VC fund invested about $7 million and harvested about $2.4 billion in 18 months. Each fund partner is said to have earned millions from this deal. When this happened, I had just joined academia, and nearly all of my MBA students wanted to be VCs, which is always a leading indicator of impending doom. It was. But the reality is that, even with all their strict criteria for selecting ventures, VCs succeed very rarely, Howard Anderson, a former VC, notes that the “common wisdom” in the VC industry is that of every 100 ventures financed, 20 are total write offs, 20 are losers, 40 are in the middle and 20 are winners. Noted author Gary Hamel estimates that out of 10 venture investments, “five will be total write offs, three will be modest successes, one will double the initial investment (19% internal rate of return per year (IRR) if exited in four years and 15% if in five years), and one will return 50 to 100 times the investment” (at 50 times, IRR is 166% if the exit is in four years and 119% if in five). Industry estimates are that only about one to two percent of businesses that VCs invest in become home runs. An additional 18 percent are said to be successes. About 20 to 40 percent of their ventures are said to be total losses, with the remainder being partial losses, or barely breaking even. About 3,000 to 3,500 ventures get VC funding annually, but fewer receive it for the first time each year. The National Venture Capital Association estimates this number at 36 percent in 2010. Using 36 percent, the range of ventures funded for the first time each year is about 1,080 to 1,260, and one to two percent of these is 11 to 25. Mark Andreessen, co-founder of Netscape and a top-ranked VC, notes that only about 15 ventures are worth investing in each year. This means that the probability that your venture will be a home run from among all new ventures is about 0.000018 (11/600,000) to 0.00004 (25/600,000). This means that about 99.996 to 99.998 percent of you may be better off growing without VC. If your venture does not become a home run with VC, your odds of making a huge fortune diminish considerably. If the venture fails, you may get a salary for the duration of your tenure with the venture, assuming the new leadership team retains you. And you get to see your baby raised by total strangers. If your venture is a success, but not a home run, the VCs are likely to get their money out first (since they invest in preferred stock) along with a return, and you may get to share the remainder, if there is any, with the new CEO recruited by the VCs and the management team. You may also lose your one opportunity to build a venture yourself and see your name in lights. MY TAKE: VCs are fond of asking promising entrepreneurs if they would rather own 10 percent of an eBay or 100 percent of a failed competitor. If you have a guarantee that you will become a home run, VC may be good. Otherwise, you are gambling with your one great opportunity – not many get two. That’s why Steve Jobs was a genius. Note that when you read about VC home runs, you read about the same companies again and again and again. There is a reason. There are very few home runs. Before you seek VC, ask yourself whether you can succeed without VC. If you can, do so. And if you do need VC, can you take the venture to the next level before seeking VC? Your fortune may depend on it.