A couple days ago, Fred Wilson of Union Square Ventures posted a spreadsheet and commentary on the economics behind a typical early stage venture capital fund.
Paul Kedrosky provides, via an old post, an interesting chart detailing the overall returns that venture capitalists provide their investors. The data is a little old, but still relevant.
In a nutshell, what these two posts illustrate is that it is very difficult to be a successful venture investor. While looking from the outside, it seems like VC's have a gold-plated life with perks coming out the wazoo. But that just ain't so.
First look at Fred Wilson's projections. He's hoping to provide his investors IRR's in the high twenties. That's good, but not staggering. I've seen real estate deals do as well with considerably less risk (I know... it's not apples to apples). Compare that goal with the actual returns of the top 25% of VC funds - it's very similar. The bottom 75% of the VC world are basically failures, providing crap returns at high risk, as Paul Kedrosky''s chart shows . VC is a very scrappy, tough business.
What this means to you as an entrepreneur is that VC's are under a lot of pressure to fight an uphill battle to please their limited partners. Their own survival depends on their ability to stay in that top echelon of VCs. Does that pressure sometimes cause the VC's interests to diverge from your own goals as an entrepreneur? Absolutely. And the VC's know this all to well. "Most" startup businesses (and by most I mean "almost all") are fundamentally incompatible with the venture capital business model. That's why they're so darned picky about what they choose to invest in. It's not ego or that they "don't get it". It's that they do get it, and they know that the investments that make their own business work are few and far between.
It takes high revenue and growth potential that can be kick started very quickly and the ability to make a nice exit in a short time frame that makes the VC model work. If any of that conflicts with your business at any time along it's growth path, then VC is not for you. Any deviation from that plan will put you in the VC's "loser" column on the spreadsheet. Too many losers and that VC is also a loser when he tries to raise his next fund.
Just as you have to think about your product from your customer's point of view, you must view your business from your investors' (and their investors') points of view. It's easy to get distracted by the huge Google-like returns that some VCs sometimes get and assume that they have an easy job. They don't. And if you don't make it easier for them, VC isn't for you.
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