VC Marc Andreessen of Netscape and Andreessen Horowitz. (Photo by Chip Somodevilla/Getty Images)
An article in the New York Times highlights the contrasting strategies of two of the most successful, top-tier venture capital (VC) funds – Benchmark Partners and Andreessen Horowitz. The article notes a divergence in the top tier of VC funds that are moving in 2 distinct strategic directions:
Small And Focused:
Benchmark is staying true to its roots, focusing on the traditional VC model of offering capital with a smaller fund, allowing senior partners to provide more hands-on support directly to entrepreneurs.
Bigger And Diversified:
Andreessen Horowitz, in contrast, is expanding significantly. The firm has larger funds, a growing staff and a higher number of ventures funded. It also offers additional services and aims to position itself as a comprehensive financial institution. Other top-tier VC funds are reportedly following Andreessen Horowitz’s lead.
Here are 3 implications for entrepreneurs from these contrasting VC strategies
1. Implications For Timing & Amounts.
Many entrepreneurs assume that “experts,” like VCs, can accurately evaluate the potential of a true startup – one with no history and no sales. Adding to the confusion, the business press, including the New York Times, often refers to all VC-funded ventures as “startups,” regardless of their stage. As a result, true startups with $0 in sales are lumped together with well-established ventures – sometimes 6+ years old with hundreds of customers. Here are two implications for entrepreneurs regarding when and how much funding to seek:
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· Timing: To attract more capital from top-tier VCs, entrepreneurs need to show billion-dollar potential. This mainly involves demonstrating strategic dominance and leadership in a potential multi-billion-dollar industry – only one percent of 85 billion-dollar entrepreneurs got VC after developing the idea (The Truth About VC at www.dileeprao.com) . This is likely to happen at later stages.
· Amounts: Larger funds, like Andreessen Horowitz, are more likely to seek ventures requiring more capital, which is likely to be at later stages. These VCs focus on companies that have already demonstrated potential. For instance, Airbnb was rejected in its early attempts and attracted major funding only after proving their market viability and growth trajectory. Similarly, Steve Jobs was rejected by nearly 10 VCs and Google by about 12.
To get to later stages and prove unicorn-potential, entrepreneurs need unicorn-skills. These skills include visionary leadership, exceptional market insight, and the ability to scale rapidly.
2. Implications For Dilution And Control
The growth of VC funds, from smaller boutique firms like Benchmark to giants like Andreessen Horowitz, has significant implications for entrepreneurs in terms of ownership and control:
· Dilution: Entrepreneurs who raise larger amounts of VC, or pursue funding too early, usually are more highly diluted than entrepreneurs who delay VC or seek smaller amounts of VC.
· Control: Entrepreneurs who lack financial savvy and depend on multiple rounds of VC risk losing control of their company. VCs often replace founders with professional CEOs – up to 85% of the time, reducing both the founders’ ownership and control. Entrepreneurs who delay VC and remain as CEO retain a higher percentage of the wealth created. Entrepreneurs who got VC early and were replaced kept about 7% of the wealth created. Those who delayed VC kept 16% of the wealth and those who avoided VC kept 52% (The Truth About VC at www.dileeprao.com).
3. Implications For Achieving Success
For entrepreneurs striving for success, there are two crucial implications:
· Capital-Intensive vs. Finance-Smart Entrepreneurs: Entrepreneurs must choose between two distinct paths: a capital-intensive strategy using large sums of VC funding from large VCs or a finance-smart approach that minimizes external funding. Among 85 billion-dollar entrepreneurs who built billion-dollar ventures from scratch, 94% chose the latter.
· VC-Success: VC is a high-risk, high-reward game with VCs succeeding only in about 19% of their investments and hitting a home run in only about 1%. Larger VC funds will need more successful ventures to stay in the top-tier, home runs that provide larger returns, and/or ventures where VCs grab more of the wealth created and dilute the entrepreneur even further. This may not be good for entrepreneurs.
MY TAKE: Unless the Top-Tier VC funds can create more unicorns or sell more of their mediocre ventures as strategic sales to corporations at inflated prices, their strategy may be at risk of failing. As funds grow larger, the combination of junior associates seeking a track record and unskilled entrepreneurs seeking more VC at earlier stages could lead to significant failures. Also, larger VC funds will need to invest more per venture, creating increased dilution that will negatively impact the entrepreneurs.
For entrepreneurs, avoiding or delaying VC while maintaining control of their ventures with unicorn skills seems to be a better bet. Building and nurturing a business is a deeply personal, time-consuming journey, and founders should not have to gamble with their future based on the competence of inexperienced VCs.
