Finally, An Honest Take on How Venture Capital Really Works
5 min read

Finally, An Honest Take on How Venture Capital Really Works

We asked a General Partner at a Venture Capital firm for honest responses to our interview questions. Find out how venture capital actually works, learn some industry secrets and get tips on how to succeed from a VC insider.
Finally, An Honest Take on How Venture Capital Really Works

How is your industry meant to work?

Venture capital exists to fund new ideas.

In theory, venture capital works when thousands of funds raise billions of dollars and allocate the money to the best ideas that will progress society. Because of the diversity of funds, backgrounds and opinions, any idea with a chance of success will receive funding by sending resources to all types of ideas.

We are risk capital on the frontier of human progress.

How does your industry actually work?

In practice, the balance of venture capitalists try to maximize their returns while minimizing their career risk. So venture capital actually has tens of thousands of funds that raise billions of dollars and allocate the money to derivative ideas that will slightly improve the existing outcome for society. Because of the echo chamber they exist in, funds chase similar ideas that are slight variations on existing solutions. They rarely send resources to genuinely new ideas.

We sell capital. Our product is cash in return for equity.

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What’s the most surprising thing people don’t know about your industry?

How little due diligence we can do on investments. It’s not uncommon to wire millions or even tens of millions of dollars to a company after what can only be described as surface level due diligence. We can justify this as a required evil to deploy funds at the pace we need to, and to remain competitive on rounds, but at the end of the day it’s not enough for a fiduciary when we’re talking about these sums of money.

What’s the last thing you would want outsiders to know about your industry?

The distribution of returns amongst people who work in venture capital, and how uneven it is. As I said, we want more people and more money chasing interesting new ideas so I wouldn’t want outsiders to know that the riches accrue to the best funds and the most senior people because it might stop them from entering or participating. I know we need to play the probabilities and encourage more people to enter, so while some don’t succeed overall there is more capital and talent at play, but that’s the truth of it.

What would shock most people about your industry if they knew about it?

We care much less about founders than we say we do. Of course we have to tell founders that we are founder friendly and will prioritize their needs, in some situations we genuinely become friends with founders. But we don’t care about them any more than we do any other human being, friend or family member. Each venture capitalist knows 50+ founders, how can we possibly deeply care about each one? There is not enough time in the day.

That said, VC’s don’t NOT care about founders (sorry for the double negative). It’s probably just a bad question to ask. We’re in business to provide money to the best ideas, we should be nice about it and treat founders with respect. Suggesting that one of your financiers needs to deeply care about you is probably a bridge too far.

What’s the dirty little secret in your industry?

I think liquidation preferences are kind of a dirty little secret hiding in plain sight. As VC’s we are investing in early stage ventures and we say that we expect 18 of our 20 investments to fail. Only 2 out of 20 will pay off big. We say that we generate all our returns from the power law, those remaining 2 pay off huge! So why do we need a liquidation preference? If we’re such good investors it should never come into play.

I’m being a little extreme here, there are scenarios where it makes perfect sense. But liquidation preferences are structured to cover all scenarios, not just the ones they should. We’re in the risk taking business, that doesn’t make sense.

What tips would you have for people so that they get the best outcome when dealing with your industry?

I’ll take this to mean founders. There are a few tips:

  • Really consider the terms being put to you,
  • You should probably push back on the terms being put to you,
  • Don’t let yourself get pushed around, and yes, they’ll try, and
  • Unless you’re a huckster, you have the power!

Then, have a very clear idea on how you want your VC’s to add value. Make sure that what you ask for is unique, like deep connections in the industry, and that you can’t get it anywhere else. Expect two or three small acts by the VC to account for 80% of the value they deliver.

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What do you wish your stakeholders would do to make your life easier?

As I mentioned, everything else being equal our returns come from the two or three good investments we make in any given fund. So I wish we could spend more time on investing activities and less time on superfluous activities like making limited partners feel special, participating in networking events and all those types of things.

It’s a simple business, and I wish we could strip it back to basics. Find asymmetric bets on interesting new ideas, negotiate the terms of an investment and watch them go.

What corners are people who work in your industry most likely to cut?

Due diligence.

Is this a good industry to work in?

It’s a dream come true. I love it. When you get involved deep enough in any industry you’ll always find problems, and it’s about understanding them so you can work around them. In its purest application, which you get to enjoy sometimes, practicing venture capital is exhilarating. There’s some wastage in the system from bad actors and misaligned incentives but it’s an amazing, interesting industry to work in where you’re always learning something new.

What would the haters say about this industry?

Other than what I have already discussed, probably something about our attitudes, how we carry ourselves and how we enrich ourselves. I totally get it because there is some bad behavior. But the best in the business pay no mind to it and just get on with the job.

What is the outlook for your industry?

Such an interesting question right now. Venture capital will always be around, there may be some changes to how we distribute and administer the funds, but it will always be around in some form. But right now there is more money in venture capital than there has ever been, by a margin. Either we’re on the cusp of an explosion in new invention and innovation, or the total funds allocated to the asset class might shrink a little. Forward looking returns will definitely be lower. The best in the business will be just fine, some people will move on to other endeavors and we’ll continue on.

Do you have any advice for people who want to work in this industry?

Become a student of venture capital, understand the history of what’s been funded in the past, build an encyclopedic knowledge of different startups in your market, really dive in and learn everything you can.

Understand term sheets, understand all the functions at a startup (Engineering, Product, Marketing, Sales, etc.), understand the key drivers. These are just examples. Basically, if you’re really interested, fill in every gap between venture capital and the companies they invest in and the people who are involved.

VC is for learning machines.

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