Re-Imagining the World without VCs

What if venture capital firms have never existed? Would it affect the current state of start-ups or not? These two questions need to be addressed since we still have “VC funding for start-ups” on the 4th position when entering a “VC funding for…” query in Google search.

But before we address those questions, let’s figure out how and why venture capital emerged.

In the past, entrepreneurs mostly received business loans instead of equity. The watershed event occurred in 1946 when the first venture capital company called American Research & Development Corporation was founded by Georges Doirot, the father of venture capital. However, it was only a harbinger of changes.

Venture capital as an asset class was established only in the 70s and was associated with the growth of the personal computing industry. If we didn’t have venture capital, we probably would not have the iPhone. Apple is a bright example of a personal computing start-up which received a large share of funding from venture capitalists.

According to the data provided in Venture Capital and Private Equity Contracting written by Douglas Cumming and Sofia Johan, Apple fundraised $518,000 in January 1978, $704,000 in September 1978 and $2.331 million in December 1980. The last share of private equity was received after the company went public in 1980. Other tech giants such as Microsoft and Google also took advantage of VCs, so that’s why we think it might help us grow, too. But is it relevant for today?

We can’t deny the great importance of VC in the 70–80s, but the problem is the process of fundraising through venture capital firms hasn’t changed much since that time. Because of this, VC doesn’t perform well in 2018. Moreover, it is built on obsolete biases that contradict the principles of equality.

What Would Happen to Start-Ups if VCs Suddenly Disappeared?

According to this report of Small Business Administration, around 220,000 businesses are started in the USA quarterly. This comprises 880,000 start-ups per year.

It’s a huge number, but how many of those were funded by VCs? Look at the graph designed by Statista:

The number of closed deals as of 2017 is only 8,076. And there is no guarantee that these venture capital investments were made on the principle of “1 deal = 1 start-up”. Still, we can equate one deal to one start-up and find out that only 0.9% of small businesses is funded by VCs. Of course, this value is not intended to be accurate, but it makes no significant difference whether we have 0.7%, 0.9% or 1.1% of funded start-ups. All these numbers remain ridiculously small.

A chance for a newborn company to be funded by a venture capitalist is negligible. 99.1% will never get funding from VCs. These numbers make it obvious that almost every modern-time start-up lived, lives, and will live in a world without VCs. Should you consider this business funding source if the odds are so low?

Obviously no, especially if you need to raise less than $1 million. Venture capital firms will pay no attention to the little stuff.

But as you can see, a lot of people are still typing something like “VC funding for start-ups” in Google. And they do this not because VC really works for start-ups. They do this only because VC exists!

So let’s imagine we’ve never had venture capital firms on the planet Earth. And here is what would be different in this case:

1. We imagine…. fewer start-ups would fail

Even though we have a bunch of very successful companies backed up by VCs in the past (such as above-mentioned Apple), the majority of “lucky” ventures who received VC funding fail. Being more precise, 65% failed to return from 0 to 1x capital, according to CorrelationVentures. And only 0.4% returned over the 50x invested capital.

There is no funding source which can guarantee that your start-up won’t fail, but statistically less risky options exist. For example, TokenData says 46% of ICOs failed in the last year. Even though each second start-up is still pushed out of the market, the success rate for ICO funded businesses is almost 20% higher.

2. We imagine… funding would come with inclusiveness

Previously in this article, we stated that VCs literally feed inequality. Not only the process of VC funding hasn’t changed since the 70s but the attitude of venture capitalists to specific population groups also stays the same.

Thus, all-female teams received only $1.9B out of $85B total invested in 2017. On the contrary, all-male teams got $66.9B. Women raised only 2% of all invested funds, and this number is scary.

What about African-American people and the rest of non-white population? Only 1% of VC backed companies’ founders are black or Latino. This is quite frustrating, too.

The point is, venture capital is centralized in hands of white, rich and usually not very young men. The majority of these men are on that list of 1% of individuals who have 50% of the wealth. Their choice is often based on their own biases and preferences so that we have such a disappointing situation.

If there were no VCs, there would be less inequality in the business world.

3. We imagine…. we would have more businesses society really needs

When it comes to the value that VC-based start-ups bring to the society, biases and preferences still play dirty tricks here.

Ross Baird says in his book The Innovation Blind Spot: Why We Back the Wrong Ideas — and What to Do About It that 78% of all VC’s money in the USA is going to only 3 states: California, New York, and Massachusetts. And this money comprises 50% of worldwide venture capital going to the ventures outside the USA.

The majority of venture capitalists reside in the major US cities and it is known that VC firms prefer investing within 150 miles of their location. They can personally benefit from funding such a start-up, what we can’t say about other locations and people living there. SMEs not really get much investment from venture capital firms (they comprise 70% of the GDP of Europe), but it is the type of businesses that benefit society. If we didn’t have VC, they would.

The same applies to the industry. If you operate in the agricultural sector, you have much fewer chances to be funded by VCs than if you operated in biotechnology. Does this mean the society doesn’t need your innovative ideas regarding agriculture? No, this means that a particular group of prominent people doesn’t need them.

Would the modern world be better without VC? If VCs won’t change their approach and adjust to the process of democratization of funding we observe right now, it would. We absolutely welcome VCs to join our Metamorph revolution to help create a better way for Founders and society and we’ll write an open letter to them next.

Join Metamorph below or contact me at maz@hypegrowth.consulting

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