Why aren’t VC firms focused on slow/modest growth startups?

jason
jason
Jan 13 · 4 min read

Yesterday’s post mocking the New York Times’ link-baiting story created a lot of debate on Twitter.

One thing that came up was, why don’t venture capitalists fund slower growth startups? Or, said another way, why don’t VCs invest in startups that grow at a normal pace?

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The number one job of a venture capitalist is to stay a venture capitalist.

This might sound cynical but, as a VC, if you don’t return enough money to your LPs (limited partners, a VC’s investors) you will not be able to raise your next fund. If you don’t raise your next fund, you’re not collecting management fees to pay yourself and your team, and you don’t have a chip stack to play in “the big game.”

If you want to STAY a venture capitalist you need to land these “dragon egg” investments — the ones that create enough value to give your LPs their money back. Dragon eggs are typically 20–40x your money back. So, you invest $7 million and get back $140–280 million.

That means, if you bought 20% of a startup for $7m, that startup was worth ~$35m, and then has to become a ~$700m to ~$1.4b exit for you to BREAK EVEN. Everyone makes money AFTER that investment, not before.

That is not easy.

VCs need to have double-digit returns every year (look up IRR for more on this) and essentially match stock market returns, with the chance of crushing them. If you match the stock market consistently, the thinking is you will eventually hit a Google or Facebook or Amazon.

“Stay in the game, stay in the game,” is the mantra.

The binary outcomes are just so yum yum, that you want to keep seeing flops (to use a poker analogy) and STAY. IN. THE. GAME.

So, the logical follow-up question is, why don’t LPs want to invest in VC funds that target slow growth startups?

That answer is even simpler, they have better options. If you want to return low single-digit returns, you can simply put your money in bonds, REITs or dividend-paying stocks — and not pay the significant fees associated with venture capital.

What about you, Jason?

For background, I’m an angel and seed investor, so my job is much different than a VC’s. I invest in 50+ startups a year and 24 of 25 investments do not result in a meaningful return (i.e., zero to 5x).

I’m banking on hitting a serious return every 25 investments, with serious being defined as greater than 50x, cash on cash (REALLY HARD TO DO).

So far, after 200+ investments, I’ve got Uber, Thumbtack, Wealthfront, Robinhood, Desktop Metal, Datastax, and Calm.com as outliers, with a couple of dozen startups doing well to very well. I would expect one or two more of those to break out, putting me at eight or 10 outlier investments (one every 20 to 25 investments).

Bottom line: there are zero LPs interested in funding startups with modest to normal growth prospects, and candidly, I don’t meet many founders who don’t want to build large businesses (obviously some selection bias there, as a Mount Rushmore-level angel investor, people don’t come to me with dry cleaners and pizzerias that often).

PS — I am blogging everyday this month! Check out my other blog posts below:

Day Eleven: “Why aren’t VC firms focused on slow/modest growth startups?”

Day Ten: “Podcast Recommendation: Cafe Insider & Stay Tuned with Preet”

Day Nine: “Podcast Recommendation: Bret Easton Ellis”

Day Eight: Day Eight: “Lean Management: The Power of the EOD Report”

Day Seven: “The Ultimate Outsider’s Hack: Read All The Biographies”

Day Six: “The Three Vendor Rule”

Day Five: “Should I move my #startup to Silicon Valley: the 2009 & 2019 answers compared”

Day Four: “How can I do an #MVP for a delivery service I want to start?”

Day Three: “As an #angel investor should I invest in a founder working on two projects (or working half time on one)?”

Day Two: “Chrome OS is the ultimate productivity hack & will exceed Mac OS marketshare — but can it challenge Windows?”

Day One: “How do you get an angel investor’s attention?

PPS — We’re hosting LAUNCH Festival in Sydney again this year, from June 18–19. We’re giving away the first 1000 tickets to founder (free!) → https://www.launchfestivalsydney.com

PPPS — We’re all set for Angel Summit 2019. 75 angel investors & venture capitalists, two days of discussion, debate, learning & late-night poker. Learn more → http://launchangelsummit.com

jason

Written by

jason

I angel invest in awesome startups... and try to build them myself. Be excellent to each other.

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