Post of the Day
December 17, 1999

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Rule Breaker Strategy

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Subject:  How Venture Capitalists Invest!
Author:  SirNeo

Ok, I've been thru a couple rounds of startup companies. I've talked to lots of Venture capitalists and had to work for them as well. While the gist of the phrase "invest like a venture capitalist" is true, one shouldn't take it too literally.

Here are some characteristics of Venture Capitalists that as investors we should not (or cannot follow):

1. Venture capitalists are short term thinkers. They expect to have 5-10 times their money back in 2-3 years and will often structure their deals such that the "interest rate" on their investment in the case of liquidation is in the %20 range.

2. Venture capitalists expect 3 out of 5 of their ventures to fail. And by fail, I mean a total loss. They just write it off.

3. Venture Capitalists, expect to put their money into a company that they are going to be able to control. They expect to be able to have a seat on the board, replace the CEO as a condition of the investment, direct the company into a new direction and/or force the company to use other companies they've invested in as partners. Venture Capitalists get involved. This mitigates their risk.

4. Venture capitalists know far more about a given company than you and I ever will. I once had to spend an hour with a psychologist hired by a VC firm that was looking to invest-- they had every major player in the company evaluated to see if they could handle the stress of a high growth enterprise. This goes beyond what the SEC would call "insider information".

1-2 show that the method of investing is very different. It is not a buy and hold approach (though if a c company is a success they won't liquidate their share of the company for many years... but they will stop putting money in or pull their money out if it doesn't become a success in a couple years-- many companies that would have been successful are put into liquidation because a VC firm wants the dough tied up in their assets. Of course, this is the side of the tech boom that you don't read about in the papers.

3-4 show that VC firms have far more control and information to mitigate their risk than an individual investor does. VC firms are able to make more risky investments because of this power and this level of information.

Now the phrase was "Like" a venture capitalist, not as a venture capitalist, so don't think I'm flaming. I'm just pointing out that for any given level of risk you take in an investment, you MUST have an commensurate amount of information, or power, to justify that risk.

I am afraid that many, many investors take risk without doing their homework, and the phrase "invest like a venture capitalist" should be interpreted as "know a company as thoroughly as a venture capitalist". I've never gone thru a due diligence process with a company that took the proverbial "nice business plan, here's $1million" approach you hear about. All of them have made it an investigation like you'd expect from the FBI-- do that level of investigation in your investments as well!


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