Overview of Venture Capital
Venture Capital Strategy is an approachable but disciplined overview of venture capital developed in the classroom over 15 years by a professional musician turned professor. Written by an educator (and former performer), the book is not a collection of personal war stories from one practitioners perspective. Rather, it is a distillation of 100’s of interactions with VCs, founders and LPs. The following is an excerpt of the introduction of the book.
Why Another Venture Capital Book?
The simple answer: I believe venture capital should be approached as a subject of entrepreneurial strategy, not finance. I have taught venture capital classes and run a global venture capital competition for over 15 years. Throughout that time, I have struggled to find materials for my students, frustrated by the simultaneous abundance and lack of available content.
There is an abundance of terrific blogs written by VCs and founders, usually teaching specific lessons relevant to specific circumstances. Many VCs are prolific writers and have covered a wide variety of topics of the VC investment process. However, most blog postings have a very narrow scope and are not organized into a coherent body of work. They do a great job of examining each tree, but the forest gets lost.
Similarly, there are plenty of textbooks that treat venture capital as a topic of finance. Wrong forest! Venture capital is undeniably a subset of private equity. However, approaching the industry from that perspective ignores the vast majority of what VCs actually do: bring new technologies into the world by helping build companies, from tiny startups with a couple of cofounders to potentially hundreds of employees and millions of customers.
Treating venture capital as a topic of finance overemphasizes the importance of numbers and quantitative analysis. For VCs, numbers play a large role, but the story about the numbers is just as important. VCs are skilled at creating a narrative to explain their analysis. In this regard, I will argue that VCs are more like journalists and filmmakers than traditional financiers.
Understanding how venture capital works in our economy can be of benefit to a wide variety of readers. Certainly, if you are a founder considering raising venture capital, you will benefit from understanding the behavior of your future equity partners. Further, you are your first investor, devoting your precious time, money, social capital and mental energy to your startup. You will benefit from learning how to think like an investor.
Professionals (and future professionals) in fields that are deeply influenced by technology will also benefit from understanding how venture capital plays an integral role in bringing innovation to market, the very disruptive technologies that may well disrupt your industry. As you consider your own career options, you may even be considering joining a venture-backed startup.
Almost all of us are touched as consumers by companies that received venture capital when they were getting started. Apple, Google, Amazon, Facebook, PayPal, eBay, LinkedIn, Twitter, and more recently Uber, Airbnb, Instagram, Dropbox, Spotify…the list goes on and on. Over 40% of U.S. public companies started after 1974 have been VC-backed.
My goal is for readers to benefit two-fold. First, you will find here a brief yet comprehensive overview of the venture capital industry, starting with an origin story and walking through what I call the VC Job Cycle. This will provide the context within which VCs do their jobs.
Secondly, I hope to help you develop your own decision-making skills with an opportunistic outlook. VCs are optimistic contrarians charged with making important go/no-go decisions every day. We can all benefit from making better decisions. Learning to think like a VC can help.
Where I’m Coming From
In the winter of 2002, I had a life-changing experience that ultimately led to an unorthodox career in academia and this book. I had no idea at the time that it was going to be so impactful. I was in the middle of my first year of graduate school pursuing an MBA, a surprising place to find myself considering how I had spent my 20s.
I had moved to Los Angeles just after college to pursue a music career. Within a few years I was touring the west coast with my band, the Zookeepers, eventually performing 500 shows in 8 states (plus one particularly memorable gig in a 12th century castle in Switzerland called Schlooss Thun).
By my early 30s, the band had evolved into a small business with a reluctant sole proprietor: me. In addition to fronting the band, I was the booking agent, manager and producer. Through savings from my day job, I had purchased most of the equipment through which we performed, the van that carried us over 150,000 miles and the basement recording studio where we produced four independently released CDs. I hired the musicians who toured and recorded with me. I created the marketing materials. I did the taxes.
I had become a small businessperson in a hit-driven California industry: entertainment. Unfortunately, after a decade in Los Angeles, I burned out before I ever hit. When I was in my early 30s considering next steps, an old friend suggested business school.
About 18 months later, as a 1st-year MBA student at UNC’s Kenan-Flagler Business School, I stumbled across a seemingly innocent little event that would change my life. The Venture Capital Investment Competition (VCIC) was in its fifth year, limping along after the dot-com bubble-burst. Interest in venture capital was waning after the crash, and only a handful of students at UNC signed up for the competition. My team and I did not take it seriously. We pretty much just showed up. That’s when my socks were blown off.
In the competition, students get to be venture capitalists for the day. Real startups come to pitch for funding. Playing the role of the investors, we, the students, had a mock VC fund from which we would invest in one of the startups. We had to choose one of the four.
We had been given four business plans from local startups that were attempting to raise venture capital. My team had (barely) read the plans the night prior and prepared a list of questions for each entrepreneur. It was clear to us which plan was the best. By this time in our MBA program, we had read many cases and completed several “integrated exercises” that incorporated all aspects of the b-school curriculum: finance, marketing, operations, management, etc.
When we arrived at VCIC, we already knew which startup would get our funding. We had applied our newly gained business acumen to tear apart the business plans just as we had torn apart dozens of case studies. And then at the event, we met the founders. Game changer!
It turns out, people matter. You can study all the theory in the world and not be prepared for the hair standing up on the back of your neck because you just don’t trust someone. There is no textbook that will fully explain the myriad variables involved with navigating a complex conversation with another human being, perhaps one who is much smarter than you, or not nearly as smart, or seems to be hiding something, or is oversharing, or is an amazingly compelling salesperson, or stumbles while explaining things…
It was an integrative exercise incorporating disciplines like marketing, finance, and operations, with the addition of real human beings. These were real founders pitching their real startups and doing their best to answer our real questions just as they’d answer to real VCs.
Prior to this event in our business school classes, we had always discussed businesses as “cases,” which were either historical or theoretical. And on paper. They had been part of a teaching module designed to impart a specific lesson, often somewhat contrived, or at the least, conveniently choreographed.
At VCIC, it was a maelstrom of variables by comparison. These were not meticulously written cases that made a clear point. These were current business plans, the real deal, being thrust upon the real world with no predictable outcomes. There were no right answers. The students were immersed into the ambiguities of an entrepreneurial endeavor, sharing in the uncertainty with the founders.
The only people in the room who seemed to understand what was going on were the VCs, the venture capitalists, who were there to judge our performances. They were watching it all as if they’d seen it a hundred times. I thought, they must be onto something.
Confession of My Conceit
I am an unlikely candidate to write this book. I am neither a successful tech entrepreneur nor a venture capitalist, nor do I hold a Ph.D. in entrepreneurial finance or strategic innovation. My knowledge of venture capital has been informed by observing and interacting with hundreds of VCs and startups while running entrepreneurship programs and teaching startup classes at the University of North Carolina’s Kenan-Flagler Business School for over a decade. My specialty is facilitating classes and events (like VCIC) in which students, startups and investors interact. This book is a distillation of the lessons I have learned through those experiences.
As a professor, I have had the unique perspective of an objective observer. I’ve met VCs and founders from all over the world and from funds of all sizes. I’ve worked with senior partners and young associates, serial entrepreneurs and first-timers. I’ve seen what gets funded and what gets a pass.
Each of the individuals I’ve met has a story to tell from a particular perspective. I have attempted to incorporate all of these perspectives in this overview of a disparate industry, as a transparent reporter of my observations. Having never been a venture capitalist nor a tech entrepreneur, I can say definitively that I am not relating my own story nor my own bias, other than the bias of an educator.
I have necessarily generalized in a way that you may find uncomfortable at times. That is a good sign! Feel free to break the rules and be exceptional. In fact, understanding and then selectively breaking rules is a key part of being an optimistic contrarian and thinking like a VC.
One of the challenges of teaching entrepreneurship is that I must necessarily convey the norms and the averages. Yet, success in this field is often defined by neither being normal nor average. I’ll share the rules, and you must decide which ones you want to break to be exceptional.
Structure of This Book
The first part of the book covers the VC ecosystem and what we’ll call the VC Job Cycle. We’ll briefly discuss the origin of venture capital and then delve into the specific job duties of venture capitalists. We’ll learn that VCs’ jobs are both incredibly interesting and extremely challenging. This will give us the context in which VCs operate.
With a firm grasp of where they are coming from, we will then dissect the VC decision-making process. In Part II, I’ll lay out an analytical framework distilled from my work with hundreds of VCs at VCIC events. I call the framework VC Razor, with a nod to Occam’s Razor, a 14th century principle that advocates taking the least complicated path. Today you might just say, keep it simple, stupid.
While this book is not focused on finance, we won’t shy away from the financial aspect of the VC decision-making process. However, we will focus on the strategic implications of the math, largely in the last chapter, Return Analysis. Rather than wait to the end, I have found it effective in class to sprinkle VC Math 101 lessons throughout the book so that we will be ready to dig into the numbers once we hit the final Fund Fit section.