Follow me @samirkaji for my random, sometimes relevant musings about venture capital.
I’m a big fan of the question and answer site Quora and think it’s an especially great resource for entrepreneurs and investors.
Earlier this year, I ran across this great question posted by an anonymous user:
“What are the best-kept secrets about venture capital?
If you have some free time, I’d encourage you to check out all of the responses, as several are extremely insightful. I’m reposting my (slightly expanded) answer below.
· Fewer than 20% of venture capital funds provide the level of risk and duration adjusted returns that meet Limited Partner expectations (2.5X+ cash on cash return).
· Even fewer individual venture capital partners (<10%) meet Limited Partner expectations.
· However, the top 1% of venture capital funds can be transformational for the investors that are lucky enough to invest in them — Think Accel IX (Facebook) or Lowercase Capital’s first fund (Uber & Twitter).
· It’s a relatively tiny industry compared to other asset classes, with only about $30B going to venture firms per year. Private Equity Buyout firms by comparison raise nearly 10X as much.
· As counter-intuitive as it may seem, bull markets bring a whole host of unique challenges to VC’s. Apart from balancing fund deployment pressures while maintaining valuation discipline, capital becomes a marginally valued commodity by the best companies and entrepreneurs. No longer can “value-add” simply be something abstract, but needs to be definitive and authentic.
· Fundraising sucks for them VC’s too, perhaps even more. With the exception of 50 or so firms, fundraising tends to be a long, frustrating campaign that can span 12 months or longer.
· It’s not a sure path to untold riches. In fact, the industry is littered with tenured venture partners who have yet to receive a carry check (carry is the VC’s share of a fund profits).
· Shiny objects matter to VC’s, too. Regardless of valuation, it’s it’s great PR for a firm to have name brand companies like Uber or AirBnB in their portfolios.
· It’s a really, really long term commitment. Most funds these days, while structured as 10-year vehicles, end up surviving 14+ years before the last company is even liquidated. During that time, VC’s are on the hook to constantly update LP’s, provide financial reporting, and do all the not- so- fun stuff that comes with running a fund.
· Economics are rarely shared equally at firms. 1st generation partners usually enjoy the bulk of carry and firm governance (a primary reason generational planning has been such an issue within venture capital). Benchmark Capital, which employs an equal carry structure for all partners regardless of seniority, is still very much the exception than the rule.
· Many VC’s won’t do deals that don’t come from a trusted source in their network.
· On paper, the delta between a mediocre VC and a great VC is razor thin. History has shown us that fewer than 50–100 companies a year drive 95%+ of aggregate venture returns for that vintage year. One massive hit is often all it takes to “mint” an investor, regardless of how serendipitous the investment was.
· It usually takes 7–10 years before you can accurately gauge how “good” an investor is.
· While a typical venture fund is quite diversified, individual VC’s at large firms have fairly concentrated positions. Most will only do 2–4 investments per year, with 4–8 positions per fund. This inherently can create political jostling as individuals focus on their own track records.
· For the hottest deals, elbows can be unbelievably sharp between investors.
· High IQ and hustle are prequisites for investors. Investors that have exceptionally high EQ’s typically are the ones that consistently win the deals they want.
· While venture capital is considered a risk taking industry, the primary exercise in investing is risk mitigation.