Venture capital plays a smaller role in funding basic innovation than most people think. In 1997, venture capitalists invested over $10 billion, but only 6% of that went to startups. The majority of venture capital funding actually goes towards follow-on funding for projects that were initially developed through government and corporate expenditures. This means that more than 80% of the money invested by venture capitalists goes into building the infrastructure required to grow a business, such as manufacturing, marketing, and sales expenses.

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Sep 10, 2023
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Venture capital plays a smaller role in funding basic innovation than most people think. In 1997, venture capitalists invested over $10 billion, but only 6% of that went to startups. The majority of venture capital funding actually goes towards follow-on funding for projects that were initially developed through government and corporate expenditures. This means that more than 80% of the money invested by venture capitalists goes into building the infrastructure required to grow a business, such as manufacturing, marketing, and sales expenses.
Contrary to popular belief, venture capitalists do not solely invest in good people and good ideas. They invest in good industries, meaning industries that are more competitively forgiving than the market as a whole. Less than 10% of all U.S. economic activity occurs in segments projected to grow more than 15% a year over the next five years. Growing within high-growth segments is much easier than doing so in low-growth or negative-growth ones. Therefore, venture capitalists tend to allocate their capital into industries where most companies are likely to look good in the near term.
Timing is crucial in venture capital. More than 80% of the money invested by venture capitalists goes into the adolescent phase of a company's life cycle. The challenge for venture capitalists is to identify entrepreneurs who can advance a key technology to a certain stage, such as FDA approval, at which point the company can be taken public or sold to a major corporation. This timing is important because investment bankers' commissions on IPOs can result in millions of dollars in commissions for just a few months of work.
Venture capitalists also protect their investments through preferred provisions and by adding credibility through the presence of multiple VC firms. In return for financing a company's start-up, venture capitalists expect a ten times return of capital over five years. The fund typically pays for the investors' annual operating budget, which is around 2% to 3% of the total capital, regardless of the fund's results. The investors receive 70% to 80% of the gains, while the venture capitalists get the remaining 20% to 30%. However, on average, only one in ten good plans, people, and businesses succeed, which is why VC reputations are often built on one or two successful investments.
While venture capital is important for funding the growth of a business, it is worth noting that nearly all basic research and invention comes from corporate or government funding. The United States is unique in its willingness to embrace risk-taking and entrepreneurship. Additionally, every company goes through a life cycle, and each stage requires a different set of management skills. The person who starts the business is rarely the one who can grow it, and that person is seldom the one who can lead a much larger company.
Moving on to the idea maze, it is essential for startup founders to understand that good startup ideas are well-developed, multi-year plans that consider many possible paths based on how the world changes. A good founder can anticipate which turns lead to success and which lead to failure. To navigate the maze effectively, founders should learn from history, both previous attempts and the knowledge shared by practitioners. Learning from the experiences of others far outweighs the risk of having their idea stolen.
Direct experience is another valuable way to navigate the idea maze. Founders can gain insights by immersing themselves in interesting mazes and giving themselves time to figure things out. It's important to focus on finding the right path rather than worrying about competition from other startups. The presence of others in the maze can actually indicate that the idea is promising. The real competition to be concerned about is wasting years going down the wrong path.
Analogies can also be helpful in building the maze. By looking at successful companies in similar industries or with similar business models, founders can learn from their successes and apply those lessons to their own ventures. For example, studying the beginnings of Airbnb can provide insights for building a "peer economy" company, while understanding eBay's early days can be valuable for creating a successful marketplace.
In conclusion, venture capital plays a crucial role in funding the infrastructure required for business growth. However, the majority of funding for basic innovation comes from government and corporate sources. Venture capitalists invest in good industries rather than solely relying on good people and ideas. Timing is essential in venture capital, and identifying competent management is a critical challenge. Additionally, founders should navigate the idea maze by learning from history, gaining direct experience, and drawing analogies from successful companies. By understanding these key points, startup founders can increase their chances of success.
Actionable advice:
- 1. Research and understand the industry you're entering. Look for industries that are projected to have high growth rates in the next few years.
- 2. Develop a long-term plan that takes into account potential changes in the market. Anticipate different paths and be prepared to adapt.
- 3. Learn from history and the experiences of others. Seek out knowledge from practitioners and study successful companies in similar industries or with similar business models.
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