How to Understand and Choose a Venture Investor | Summary and Q&A

TL;DR

This content provides insights into the venture capital industry, including how to choose the right venture capitalists, understanding their incentives, and navigating the fundraising process.

Key Insights

• ✳️ The venture capital industry has transitioned from being the main source of funding to a provider of risk capital and permanent financing for high-risk businesses.
• 🎓 Limited partners, such as university endowments, provide the capital for venture capitalists to invest.
• ⏳ The J curve represents the initial period of negative cash flow for venture capital funds before generating positive returns over time.
• ❓ Start-up CEOs should prioritize finding financial investors before considering corporate investors to ensure alignment of interests.
• 🔠 Venture capitalists offer more than capital, providing guidance, support, and connections to help start-ups grow and succeed.
• 🌱 The competitive landscape of venture capital will continue to evolve, with more emphasis on seed funding, longer time to IPO, and a blending of private and public markets.
• 💄 Start-ups should consider the decision-making process of venture capital firms to understand the dynamics and potential challenges.

Transcript

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Questions & Answers

Q: How do venture capitalists obtain funding?

Venture capitalists receive funding from limited partners, which can include university endowments and other institutions with the goal of earning high returns on their investment.

Q: What is the significance of the J curve in venture capital funds?

The J curve represents the initial period of negative cash flow for venture capital funds, as they invest in start-ups. Over time, returns start to generate positive cash flow as successful investments are realized.

Q: Should start-up CEOs prioritize financial investors over corporate investors?

Start-up CEOs should consider financial investors first, as they are solely focused on providing capital and supporting start-up growth. Corporate investors may have other strategic interests that could hinder future partnerships or acquisition opportunities.

Q: How do venture capitalists differentiate themselves and provide value?

Venture capitalists differentiate themselves by offering more than just capital. They provide guidance, support, and connections, making them valuable partners for start-ups looking to grow and succeed.

Summary

In this video, Frank Chen interviews Scott Cooper, the managing partner at Andreessen Horowitz, about the fundraising process for startups. They discuss topics such as how to choose the right venture capitalist to work with, how venture capitalists make money, the role of corporate venture capital, and the future of venture capital.

Questions & Answers

Q: Why did the world need venture capitalists in the past?

The world needed venture capitalists in the past because they had the money that startups needed to raise. Banks were not usually willing to lend money to risky businesses, so startups turned to venture capitalists for funding.

Q: What is the role of venture capital in financing startups?

Venture capital is considered risk capital that is necessary for financing businesses that cannot be financed through other means like loans. Loans are not suitable for startups because they are often considered too risky, and they also require repayment after a certain period of time. Venture capital, on the other hand, offers permanent capital that does not need to be repaid unless the company exits through an IPO or acquisition.

Q: How do venture capitalists get their funds?

Venture capitalists get their funds from limited partners (LPs). LPs are typically institutional investors, like university endowments, who are looking to earn high returns on their investments. They provide the capital that venture capitalists use to invest in startups.

Q: How do university endowments use venture capital?

University endowments, like the ones at Stanford and Yale, allocate a portion of their funds to venture capital. They view venture capital as a high-risk, high-return asset class that can generate the returns necessary to support the university's expenses and subsidize college education.

Q: How do university endowments construct their portfolios?

University endowments follow a diversified portfolio strategy. They invest in different asset classes, including venture capital, to achieve diversity and higher returns. Yale, for example, allocates a significant percentage (around 40-50%) of its assets to private equity and venture capital, as it believes these assets have the potential to generate abnormal returns.

Q: How do venture capital funds make money?

Venture capital funds make money through a power-law distribution. Around 40-50% of the companies they invest in may not succeed at all, with a small percentage generating significant returns. Thus, the success of a venture capital fund relies on finding companies with the potential to generate high returns, like Facebook or Google.

Q: What types of businesses are attractive to venture capitalists optimizing for high returns?

Venture capitalists who are optimizing for high returns are attracted to businesses with significant growth potential and the potential to achieve substantial exits, such as IPOs or acquisitions. These businesses aim to disrupt large markets and have the potential to scale rapidly.

Q: Why do venture capitalists prioritize faster growth and higher margins?

Venture capitalists prioritize faster growth and higher margins because the success of venture capital funds depends on finding companies that can generate outsized returns. These returns are necessary to offset the losses incurred by unsuccessful investments.

Q: How does the J curve in venture capital funds work?

The J curve illustrates the cash flow pattern of a venture capital fund. In the early years, the fund invests money, resulting in negative cash flow for limited partners. Over time, if the fund's investments are successful, it starts generating positive returns. The J curve is more relevant for limited partners than for entrepreneurs seeking investment.

Q: Do general partners in venture capital funds invest their own money?

General partners in venture capital funds do invest their own money, albeit in varying percentages. Some funds might allocate around 1% of the fund from general partners' capital, while others could have higher percentages. General partners' investment in the fund demonstrates their alignment and commitment to the fund's success.

Q: What is the difference between general partners with economic interest only and general partners with governance interest?

The difference between general partners with economic interest only and general partners with governance interest lies in their level of involvement in the management company around the fund. The distinction is more relevant to the firm's structure than to entrepreneurs seeking investment.

Q: Does it matter if venture capitalists have economic interest only versus governance interest?

As an entrepreneur seeking investment, it is less crucial to focus on whether venture capitalists have economic interest only or governance interest. The more critical aspect is understanding the decision-making process within the venture capital firm, including who the decision-makers are and how they evaluate investments.

Q: What incentives drive corporate venture capitalists and how do they differ from financial investors?

Corporate venture capitalists have incentives to invest in startups that align with their corporation's long-term strategy. While they aim to earn a return on their investments, their primary goal is often strategic maximization rather than pure profit maximization. Additionally, corporate venture capitalists typically don't face the same pressures regarding fixed investment periods.

Q: When should I accept corporate venture capital?

Accepting corporate venture capital can be beneficial if it aligns with your startup's long-term goals and provides strategic value beyond just financial returns. However, it is essential to ensure that you don't give away too much control or risk limiting other potential partnerships or acquisition opportunities.

Q: What is the value of specific advice and dedicated one-on-one help from a venture capitalist compared to crowdsourcing?

Venture capitalists provide value beyond just capital. Their experience, network, and guidance can be invaluable to startups. While you can crowdsource advice from various sources, venture capitalists offer personalized and specialized advice tailored to your specific situation.

Q: How will the venture capital landscape look different in the next 10 years?

The venture capital landscape is expected to become even more competitive, with an abundance of available capital. Startups may stay private for longer periods, and the timeline between private and public markets may merge, with the emergence of an active secondary market for private stock. The role of venture capital will increasingly need to provide value beyond capital to remain relevant.

Takeaways

The world needed venture capitalists in the past because they had access to the funding that startups needed. However, with the availability of alternative funding sources, venture capitalists must provide value beyond just capital to remain relevant. Startups should consider their alignment with venture capitalists' incentives, understand the decision-making process within the firm, and evaluate the long-term partnerships and flexibility that venture capitalists offer. The venture capital landscape is expected to become more competitive, with longer periods of staying private and a merging of private and public markets.

Summary & Key Takeaways

• The venture capital industry has evolved from being the main source of funding for start-ups to now providing risk capital and permanent financing for high-risk businesses.

• Limited partners, such as university endowments, provide the capital for venture capitalists to invest in start-ups.

• Venture capital funds follow a J curve, where they initially invest money and experience negative cash flow before generating positive returns over time.

• Start-up CEOs should prioritize finding a financial investor first before considering corporate investors, ensuring their interests align and that the corporate investment does not hinder future partnerships or acquisitions.

• The role of venture capital goes beyond providing capital, with venture capitalists being valuable partners who offer advice and expertise to support start-up growth.