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Modern Day Cowboys

Modern Day Cowboys

Today’s venture capitalists look more like bankers, and the entrepreneurs they fund look more like M.B.A.’s.

The U.S. venture-capital industry is envied throughout the world as an engine of economic growth.

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I am passionate about Investment and most importantly investing in businesses directly. Had a conversation with the VC Lab on the formation of my new Venture Capital firm and I needed to compare my fundraising strategy with what I can find on the internet, and that led me to this article by Harvard Business Review (One of my favourite places to go lol)

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MORE IDEAS FROM How Venture Capital Works

One myth is that venture capitalists invest in good people and good ideas. The reality is that they invest in good industries—that is, industries that are more competitively forgiving than the market as a whole. 

Now, more than 25% of disbursements are devoted to the Internet “space.” The apparent randomness of these shifts among technologies and industry segments is misleading; the targeted segment in each case was growing fast, and its capacity promised to be constrained in the next five years.

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Venture capital’s niche

It exists because of the structure and rules of capital markets. Someone with an idea or a new technology often has no other institution to turn to.

Historically, a company could not access the public market without sales of about $15 million, assets of $10 million, and a reasonable profit history. To put this in perspective, less than 2% of the more than 5 million corporations in the United States have more than $10 million in revenues.

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Venture money is not long-term money.

The idea is to invest in a company’s balance sheet and infrastructure until it reaches a sufficient size and credibility so that it can be sold to a corporation or so that the institutional public-equity markets can step in and provide liquidity. In essence, the venture capitalist buys a stake in an entrepreneur’s idea, nurtures it for a short period of time, and then exits with the help of an investment banker.

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Venture capital fills the void between sources of funds for innovation (chiefly corporations, government bodies, and the entrepreneur’s friends and family) and traditional, lower-cost sources of capital available to ongoing concerns.

Filling that void successfully requires the venture capital industry to provide a sufficient return on capital to attract private equity funds, attractive returns for its own participants, and sufficient upside potential to entrepreneurs to attract high-quality ideas that will generate high returns.

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Venture Capital Fills a Void

Venture money plays an important role is in the next stage of the innovation life cycle—the period in a company’s life when it begins to commercialize its innovation. We estimate that more than 80% of the money invested by venture capitalists goes into building the infrastructure required to grow the business—in expense investments (manufacturing, marketing, and sales) and the balance sheet (providing fixed assets and working capital).

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Investors in venture capital funds are typically very large institutions such as pension funds, financial firms, insurance companies, and university endowments—all of which put a small percentage of their total funds into high-risk investments. They expect a return of between 25% and 35% per year over the lifetime of the investment. Because these investments represent such a tiny part of the institutional investors’ portfolios, venture capitalists have a lot of latitude. 

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Timing Is Everything

More than 80% of the money invested by venture capitalists goes into the adolescent phase of a company’s life cycle. In this period of accelerated growth, the financials of both the eventual winners and losers look strikingly similar.

Picking the wrong industry or betting on a technology risk in an unproven market segment is something VCs avoid.

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From a venture capitalist’s point of view, the ideal entrepreneur:

  • delivers sales or technical advances such as FDA approval with reasonable probability,
  • tells a compelling story and is presentable to outside investors,
  • recognizes the need for speed to an IPO for liquidity,
  • has a good reputation and can provide references that show competence and skill,
  • understands the need for a team with a variety of skills and therefore sees why equity has to be allocated to other people,
  • works diligently toward a goal but maintains flexibility,
  • gets along with the investor group.

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Equity has different meanings depending on the context. Shareholder's equity is the most common type of equity - it represents the amount of money that a company's shareholders will get if all of the assets were liquidated and all the debt was paid off.

Equity can be found on a company's balance sheet. Analysts use this data to assess the financial health of a company.

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What Is Bootstrapping?
  • Bootstrapping is founding and running a company using only personal finances or operating revenue.
  • This form of financing allows the entrepreneur to maintain more control, but it also can increase financial strain.

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