Conventional wisdom has it that when the venture capitalists come calling you excitedly take the cash and use the funding to transforming your startup into a fast-growing market leader. But given most VC business models assume a high percentage (sometimes as much as 90%) of their investments will fail, should an offer of funding really be that exciting for a small business?
Recently I’ve witnessed VCs cause utter turmoil at promising startups. The story is always remarkably similar – the investment firm will take a board seat, push for exponential growth and drive the startup to the brink of collapse – and often over it. They can destabilise sustainable businesses in their quest for a fat exit, removing key staff and even founders as they try to pump the valuation further and further north.
Rather than taking startups forward I fear they may take many businesses backwards – and the fact that high failure rates are built into their balance sheets should make all of us wary.
The stats are striking when you look at studies examining the venture capital industry. The consensus established by The National Venture Capital Association is that just 30% of their investments fail, but examine studies carried out impartially and you’ll find figures considerably bleaker.
An extensive study by Shikhar Ghosh – a senior lecturer at Harvard Business School – found that of 2000 VC backed companies around 75% failed to make a return for investors, and 30-40% resulted in investors losing all of their money.
If you dig a little deeper you find that 95% of the companies studied did not deliver the anticipated return for their investors – meaning if you get involved with a VC you have a 1 in 20 chance of being considered a successful investment.
These figures go some way towards illustrating that, far from carrying the midas touch as many investees assume they will, the majority of VCs instead carry the sword of Damocles.
Having witnessed it myself (though mercifully not in my own company) I’m in no doubt that their strategic interference is shaping a lot of these failures. Whilst they’re perfectly entitled to a voice after delivering investment, contributions at board level focused solely on inflating company valuations are counterproductive – and in many instances destructive.
With so many other sources of finance now available (think StartUp Loans or crowdfunding), does it make sense for young companies to deliberately jump into a pool where 40% of entrants will drown and 55% will be left treading water?
A cheque with lots of zeroes can be a difficult thing for a struggling entrepreneur to turn down, but keep in mind you’re just another investment to most VC firms, and it’s no skin off their nose if you fail.
Darren Fell is a serial entrepreneur and MD of Crunch Accounting.