Venture Capital Math
By
William Cate
[http://home.earthlink.net/~beowulfinvestments/]
[http://home.earthlink.net/~beowulfinvestments/globalvillageinvestmentclubwelcome/]
Venture Capitalists (VC) and Angel Investors are betting against the odds. It's exciting. That's good since it can't be consistently profitable. They would be better served betting their money playing craps in Vegas or Atlantic City.
What Are the House Odds?
In craps, the house as a 1.41% edge against the bettors. The U.S. Small Business Administration (SBA) tells us that fifteen startup companies will succeed out of every one hundred that open their doors. However, among those fifteen winners, almost all are local franchises of national companies or professional firms, like veterinarians, accountants, attorneys, etc. A realistic estimate is that one startup company, with a national market for its goods or services, will succeed out of every one hundred that open their doors. This means that Venture Capitalists and Angel Investors are betting upon a 100-to-1 long shot. Assuming they randomly bet on these startups, their one winner would have to return one hundredfold to breakeven. However, a successful private company investment is far more likely to return five to tenfold than anything near the one hundredfold return needed to breakeven. There is always a steady extinction of angels and VCs. There will be a major extinction when the market takes a major turn downward as it did with the bursting of the DotCom bubble in 1999.
The Angel Investors' Secret Formula To Investment Failure
Angels can easily be easily sub-divided into two groups. There are individuals who have become relatively wealthy thanks to their education. This would include doctors, attorneys and accountants among others. There are individuals who have become relatively wealthy thanks to creating or inheriting a successful business.
For most students to succeed in school, they must accept the textbooks as gospel. Over the years that they work their way into professional school they come to believe that what is written is true. It's this belief, combined with a failure to understand the odds against them, that ensures their investment failure. They tend to strongly rely upon the startup company's business plan. They accept it as true. Assuming that they like the entrepreneur, they invest with the full expectation of the business plan proving to be reality. They are truly surprised when this doesn't happen.
Successful entrepreneurs want to prove to themselves that their success wasn't a fluke. They want to prove to everyone else that they are smarter than the average bear. This emotional baggage and the odds against s success ensure they will eventually fail.
Angel investors should not ask: "How much can I make from this speculative investment? Rather they should ask: "How likely am I to lose my risk capital?"
If the odds of loss are greater than one or two percent, no matter how attractive the investment, they should keep their wallet in their pocket. At least one Venture Capital Club, the Global Village Investment Club (GVIC) runs on this philosophy and appears to be thriving. While most Venture Capital Clubs are in the process of dying or have already been buried. If any reader wants to contact the GVIC, email me at: Beowulfinvestments@Yahoo.com
The Venture Capitalists' Secret Formula To Investment Failure
Venture Capitalists argue that an investment formula based upon two winners, two losers and three breakeven investments is profitable. That their staff based upon the staff's education at prestigious schools and the firms' investment experience ensure success. It isn't so. You need only compare a directory of VC Firm from a decade or more ago with a current directory to see that there has been a steady death rate in the industry.
What's wrong with their math is the assumption that education and experience can overcome odds of 1-in-100 against a winner. There are too many variables to be offset. It's been my experience that the role of staff is more in finding accredited investors than in finding successful startup companies. Experience has more to do with raising risk capital than in making a profit. A couple of very successful investments can carry the firm for decades on the risk capital of later investors who hope or expect to see a profit. If Venture Capitalists were consistently successful, they wouldn't always be searching for new blood to fuel the financial demands of the company.
The Conclusion
Ask not how much money you can make from a speculative investment, but rather how likely you are to lose your risk capital.
To contact the author visit:
[http://home.earthlink.net/~beowulfinvestments/]
[http://home.earthlink.net/~beowulfinvestments/globalvillageinvestmentclubwelcome/]
About the Author
He has been the Managing Director of Beowulf Investments [http://home.earthlink.net/~beowulfinvestments/] since 1981 and is the Executive Director of the Global Village Investment Club [http://home.earthlink.net/~beowulfinvestments/globalvillageinvestmentclubwelcome/]