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Mothers - don't let your sons grow up to become Venture Capitalists
South Park Blue Suit
ohhim
Had my 4th "funding early stage ventures" course tonight w. Frank Demmler and I think I'm starting to get the hang of how the whole Venture Capital thing works.

For those of you who don't quite know what a Venture Captialist is (or "VC" in shorthand), I should probably give a quick 30 second explanation.

Basically VC's are compulsive gamblers who loan money to entrepreneurs with businesses that don't have much of tangible value, but believe that with enough investment, could become the next pets.com. Because most companies will fail, VCs have to try to find the most promising looking deals and usually demand pretty high rates of return once they choose which companies to invest in.

Is that it?

Well... sort-of. Like any industry, some side issues make things a bit more complicated than they need to be (which is a good thing because otherwise, the mini-semester course I'm in would be pretty darn dull).

Side issue 1: The VCs needs to convince others to give them money so they can invest it.

To get around side issue 1, VCs create limited liability partnerships (so investors won't worry about going to debtors prison), promise big returns and project some sort of image of intelligence so that people with money (e.g. pension funds, high net worth individuals, university endowments, etc..) think that they are smart and give them money. A few other strategies also work like stating that you have a fund objective that is in line with some area of expertise you claim to have (e.g. biotech fund, IT fund, nanotechnology fund, software fund, $5-$10 million fund, etc..). This whole process tends to go pretty well if you have had some success in the past.

Side issue 2: You can't legally loan money to people at a 50% interest rate and even if you could, if you just told a person that you want a 50% return, most folks wouldn't accept the money.

To get around side issue 2, VCs dig deep into the world of finance and basically create these super complicated financial transactions (listed on "term sheets") which can usually be reduced to a nice table that says: If we sell/IPO your company for X, you keep Y, and we keep X-Y and if it doesn't look like X is going to get big enough, we'll fire all of you and take everything. These agreements use all sorts of legal terms like "preferred stock", "full ratchet", "option pools", "vesting", etc... that obfuscate things so the entrepreneurs don't know what they are agreeing to.

That's about it.