Entrepreneur Myths (40 page)

Entrepreneur
Myth 56
| Venture capitalists are vultures

How many times have you heard an entrepreneur use the term “vulture capitalist”? Sure, when I was a young entrepreneur and not yet a VC myself, I had no problem with other entrepreneurs saying it. Funny things happen when you grow up to become one of those VCs. Now the term “vulture capitalist” hurts my feelings a bit. Remember, VCs, including me, have feelings too.

One night, over a few sips of red wine, I thought about the “vulture” terminology. I decided the term should be eliminated from any and all entrepreneurs’ vocabulary. It’s the wrong terminology — both technically and intellectually.

Venture capitalists are not vultures — they are more like cheetahs

If we look at the funding process of a startup like Groupon, we learn the real story of how startups get funded. Andrew Mason had an idea to change the world. He received funding from and angel investor to get his idea off the ground. Unfortunately, it didn’t work. So he shifted gears and pivoted toward group or social buying.

What’s hidden behind the success of Groupon is the funding process itself. Mason was funded by an angel — which is kind of like an ant (the angel investor) in nature foraging for food (Groupon in this case). Once Andrew was lucky enough to gain traction, the vulture capitalists or what I call “cheetahs” came in to play and funded his ass with a substantial amount of money. The venture capital money was necessary to prove that the Groupon business model could scale quickly at the national and global level. However, if you plan to dominate the entire social buying galaxy (plus create exits for early investors), you will either sell out to a bigger player like Google (what I call “going Googlio”) or get on the IPO train.

Groupon turned down going Googlio, and instead took the IPO road in order to generate additional cash for growth, exits for current investors, and liquidity of stock to acquire other companies — this was their best strategy. However, Groupon could not have done it without the help of cheetahs. Mason’s angel investor could only invest so much money to grow the business.

In summary, what you’ve got is (1) an ant investing into the early, unpredictable and chaotic stage of the startup process, (2) a cheetah investing into the growth phase and the emerging phase, (3) the markets, such as Wall Street, looking to invest into the domination phase of the markets — like a big fucking gorilla.

Ant to Cheetah to Gorilla — that’s how it really is and how it really works. There is no room for vultures in the early-stage game of investing — especially when it comes to high tech.

“Vulture” is a bad analogy for a venture capitalist. Having been one, I assure you that we are not vultures. We’re cheetahs because we need to be fast, smart, agile and quick. My test for measuring the experience of an entrepreneur is to determine whether they see venture capital as vulture or cheetah capital. The experienced ones will choose ”cheetah.”

Why VCs are not vultures

In nature, vultures are scavengers waiting for “dead meat” to become available for their feast. Vultures are quite lazy about finding their game. They don’t chase it. Vultures wait around for some other animal, such as a lion or cheetah, to make the kill. When the time is right, the vultures gather into a committee and encroach on the predator during mealtime. The vortex of vultures, by their sheer numbers, chases the other animals away, and then dines on the remaining scraps.

Venture capitalists act like scavengers in trying to find the right deal to fund, making sure they don’t miss out on another Google, Facebook, Zynga or Groupon — but the angels, who act like ants, conduct the same process when they scour the startup environment, looking for the next AirBNB or Twitter in the seed stage. There is heavy work involved in the scouring and searching process, my dear entrepreneur friends. Most entrepreneurs do not realize how much time VCs spend looking for the right deal. Conducting due diligence is capital-intensive for investors — unless they are one of those “sheep investors” simply following the investor crowd.

When a VC tries to take a huge chunk of your business for investing millions of dollars into your venture, it’s not because they’re a vulture — they are a cheetah. VCs, like cheetahs, need as much food as possible because they don’t know where their next meal is coming from. VCs need a good chunk of flesh from your business because most of the investment they make will not give them the returns they need to satisfy their limited partners. If you’ve watched a documentary about cheetahs in Africa, you know that it’s not easy for them to catch their next meal — despite being the fastest animal on the planet. Even female lions have to hunt in packs to bring food to the table.

According to Arthur Rock, the father of the VC industry, in the last 10 years the VC industry has not broken even. The math is simple. Out of 10 companies that a VC invests into, the likelihood of getting a big hit is 10%. This is worse than going to Las Vegas. A cheetah’s odds in the jungle of catching their prey are better — but not by much.

Basically, VCs take huge chances trying to find that one big hit. Finding a new hit isn’t easy because there are so many variables at play in the early phases of a venture’s life cycle (See Myth 57: A power law works in your favor). Today’s VCs are competing with other VCs, and startups don’t need VCs as much as they did a few years ago. Entrepreneurs today can show much higher market traction, due to the ability to develop digital products or services at 10% of the cost in the early 2000s.

What makes it even harder is that bold investors, like Russian investor and entrepreneur Yuri Milner, are changing the dynamics of the venture capital industry. They are acting like king cheetahs by providing exits for early investors and startup employees, in addition to putting a substantial amount of money on the fucking table at reasonable terms for further growth. This makes it harder for other VCs to make power plays on entrepreneurs.

Looking back over the years, VCs were never vultures. They were simply misunderstood by inexperienced entrepreneurs. Like a cheetah, VCs must move swiftly when the market momentum moves in a positive or negative direction. For example, right after 9/11, most cheetahs stopped investing until they saw how the global markets would play out. This is no different than how a cheetah on the African savannah waits for the right opportunity, to chase the right prey, at the right time, under the right environmental conditions.

When a cheetah moves, it almost flies. A cheetah runs even quicker than a Ferrari: 0 to 70 mph in less than three seconds. They move with so much beauty, speed and finesse that it is art in motion. This is what happens in the VC industry as well. When markets change, the cheetahs come out to play quickly, as evidenced by incredibly high valuations, and sprints to the IPO Wall Street pond — waiting for a quick exit.

A cheetah runs fast over short distances, but it can’t sustain its high speed for more than a few hundred yards. It runs out of energy due to the massive exertion of force it applies to generate such rapid acceleration. These same principles apply to the VC business. Cheetah investors are not as big as the financial markets — so they act quickly, before the big, bad-ass gorilla (Wall Street) comes to play — with millions of investors looking for the next high-flying stock.

Venture capitalists are at the mercy of the Wall Street gorilla for their exits — unless they are lucky enough to go Googlio at an attractive acquisition price. Because the dynamics of the venture capital industry have changed over the last two years, they have to move even more quickly, making decisions at cheetah-like speed. The dynamics are changing for cheetahs somewhat because Sharespost and Second Market are building a market before the Wall Street market. Things will continue to evolve but one thing is for sure, VCs are cheetahs because they will always need to move quickly to create in and outs in the market quickly.

My advice: An entrepreneur who believes a VC is a vulture is ignorant and inexperienced. So if you’re looking for money from VCs, think of them as cheetahs — because that’s what they are in reality.

In nature, the life of a cheetah is a tough life. They are not the strongest cat in the world, and they can actually get hurt by the prey if they don’t know what they’re doing. Speed, agility, and quickness are their main weapons of attack and defense. When you analyze their body structure, you can see they were designed by God because they are built for high speed.

Next time you are tempted to use the word “vulture,” reframe your mind and replace that image with a cheetah. I know the VC you’re pitching on your billion dollar idea will appreciate the respect they deserve. They might even happily yelp in approval.

FYI: Cheetahs do not growl. They yelp.

Brain Candy: questions to consider and ponder

(Q1)
Have you ever called a VC a “vulture” to your friends? What about to the VC’s face?

(Q2)
Do you think cheetah is a better name for a VC? If not, what name do you suggest?

(Q3)
Have you ever seen a real cheetah? Have you ever seen it run on TV or in the wild?

Entrepreneur
Myth 57
| A power law works in your favor

Power law is something most VCs (I call them cheetahs) intrinsically understand. But entrepreneurs need a better understanding of the principles behind the power law.

The power law principle comes from science — complexity science. The principle is simple: The occurrence of any major event happens less seldom than smaller events. Take for example, earthquakes. Every day, there are thousands of earthquakes — from small tremors to earthquakes that register on the Richter scale but are no threat to humans. The big earthquakes, like the one in San Francisco in 1982 or in Japan in 2011, occur less often — but they do occur. These are big and rare events.

Power law is a mathematical relationship between two quantities, limiting the distribution of random processes. It is prevalent in nature, limiting things such as neuron connectivity, or frequency and size of earthquakes. It works to limit things like distribution of wealth, frequency of terrorist attacks, and friend networks. Under suitably weak conditions, if these events or occurrences are the result of underlying processes, they will converge to a power law distribution which limits and stabilizes the distribution. This is closely related to Pareto's 80/20 rule which governs the distribution of income or wealth in populations.

Power law in business

Power law applies to anything that depends on huge hits — the entertainment, publishing, toy, gaming and venture capital industries, for example.

In the film industry, it’s not every day you see a hit like
Avatar
,
Titanic
,
Toy
Story
,
Shrek
,
Pirates
of the Caribbean
or
Lord of the Rings
. In the music business, Lady Gaga, Justin Bieber, Eminem or Garth Brooks were not discovered on American Idol. In the book business, who would have thought that two women, coming from the periphery of the publishing world, would revolutionize an industry begging for large hits, with the
Twilight
and
Harry Potter
series? How about those damn Tyco’s Beanie Babies or Teenage Mutant Ninja Turtles? You’d think that with all the game innovations by Electronic Arts and Disney, they would have come up with Angry Birds. But they didn’t. Huge hits are difficult to predict or create.