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The truth about venture capitalists

Venture capitalists are either exalted as the engine of economic growth or demonised as greedy and exploitative. Jim Gunton of NJTC Venture Fund attempts to dispel some of the misconceptions surrounding venture capital.

I've observed the venture capital industry for nearly the past decade and have witnessed the profession alternately: (a) deified as the stimulus for America's economic advantage; or (b) venomised as exploitative. No doubt the truth lies in between, but as a venture capitalist here are seven misconceptions I feel compelled to set straight:

Misconception #1: Venture capitalists desire majority control of an entrepreneur's business.

Truth: Venture capitalists desire compelling returns on their money. Most venture capitalists realised long ago that the benefits of majority control did not exceed its corresponding headache and insomnia. Since venture capitalists generally are involved with six to eight companies at once, controlling and running that plurality of companies is impossible. Owning significant equity to create a material return is the more important objective, which usually means five to 40 per cent ownership. As an aside, entrepreneurs motivated by control are likely to be ill suited for investors whose principal objective is achieving 30 to 40 per cent annual ROI.

Misconception #2: Venture capital is equity targeted to start-ups.

Truth: While historically the expression ‘venture capital' meant high-risk financing for start-up initiatives, today the dynamic is different. Since 1980, venture capital has grown as an asset class from $3bn to several hundred billion dollars under management, with just a fraction invested in seed and start-up ventures. For example, only five percent of New Jersey's venture financings benefited seed and start-up companies in 3Q 2001. The bulk goes to later-stage businesses whose larger valuations better support the sizable dollar investments required by institutional investors.

Misconception #3: Venture capitalists do not have to ‘sell'. Their job is simply to ‘buy', ie: invest in the best companies that walk in their door.

Truth: Venture capitalists constantly must ‘sell'. To begin with, to raise a venture capital fund a venture capitalist had to persuade investors to commit their money. Moreover, most terrific investment opportunities will not present themselves to the venture capitalist. Even in today's recessive economy, entrepreneurs can obtain capital through friends and family, state and federal governments, stretching credit cards or accounts payable, angels, banks, corporate partners, other venture capital funds, etc. To gain entry into a competitive investment a venture capitalist must persuade the entrepreneur his money is ‘greener', ie: his Rolodex and other contributions are more valuable.

In short, to close a deal, raise follow-on financing, recruit talented management, achieve exit liquidity: all require ‘selling'.
 

Misconception #4: Venture capitalists are unethical (and beady-eyed).

Truth: Venture capitalists could be beady-eyed, which would explain the occasional remark that ‘venture capitalists are snakes'. However, in my experience, venture capitalists are neither more nor less scrupulous than other professionals. Moreover, because the community among entrepreneurs is a small one, unethical behaviour becomes widely known, limiting, if not eliminating, the good deals in which a firm with a tarnished reputation can participate.

Misconception #5: Venture capitalists are investment bankers.

Truth: Venture capitalists develop long-term (three to ten year) relationships with the companies they invest, compared to the shorter transactional work (ie an initial public offering or acquisition) achieved by investment bankers. Investment bankers are compensated per transaction whereas venture capitalists only benefit if a company succeeds.

Misconception #6: Venture capitalists enjoy leisurely workweeks.

Truth: In the US today there are 600 to 700 venture funds. Over the last 20 years the industry has become highly specialised and competitive, with many funds ‘going out of business' because they are unable to raise a next fund. Misconceptions about venture capitalists sprang from the 1950s and 1960s when Rockefeller, DuPont and other wealthy families were the sole sources of venture financing. But the reality is that keeping pace with entrepreneurs, often working with five or six intimately while simultaneously evaluating five to ten new investment opportunities, is time consuming. Successful venture capitalists average six-day workweeks.

Misconception #7: Venture capitalists are pecuniary.

Truth: This misconception is overly encompassing but it should be noted that venture capitalists can be exemplary philanthropists. For example, Edison Venture Fund's John Martinson regularly donates to needy organisations and recently committed $500,000 to a Trenton-focused foundation for the educationally underprivileged. BaseCamp Ventures' Mel Baiada has donated millions of dollars to local schools. Former Patricof & Co. General Partner Robert Chefitz serves on the Board of New York City's Redevelopment Fund as well as World Link.

Copyright © 2002 NJTC Venture Fund

Jim Gunton is a general partner of the NJTC Venture Fund

NJTC Venture Fund is an early-stage venture capital fund affiliated with the New Jersey Technology Council. For more information, visit www.njtcvc.com