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VENTURE CAPITAL

4 Things You Get Wrong About Venture Capitalists

Make sure you understand your potential investor and your relationship with him or her.
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Venture capital comes with strings attached, right?

Some widely held views about those strings simply aren't true. Luke Burns, a graduate of Harvard and MIT's Sloan School of Management, is a partner at Boston's Ascent Venture Partners. The firm has invested in more than 100 startups through five funds. He described the four biggest misconceptions about VCs and what you should do about them. 

1. All VCs fire founders after investment.

Company founders often worry that venture capitalists will replace them after they invest. VCs do fire founders if they are unable to lead the startup to rapid growth. 

But Burns argues that venture capitalists give founders a chance to prove themselves. "The biggest problem we encounter with founders is that they hire talented executives but can't keep them because they micromanage," he says. "Founders need to change how they manage, so those hires succeed in their jobs. We coach founders for as long as two years. But if they can't function in the new role required for their startups to grow, we let them go." 

2. Venture capitalists dilute founders' equity stakes.

Company founders tend to discount the contribution of venture capitalists and resent watching their equity stake shrink as more outside capital comes onto their balance sheet.

But Burns argues that entrepreneurs can minimize their dilution by meeting investors' expectations for rapid growth: "If we invest in a company with $1 million in revenues, we expect it to grow to $3 million. If it's $5 million or $20 million in revenues, we want a double. Venture capitalists have limited partners and they have to take a big stake to make the numbers work for investors," he says. "If a startup only grows 25 percent, the founder will get more diluted than if he meets investor expectations for 100 percent growth."

3. VCs don't work as hard as entrepreneurs.

Entrepreneurs want investors to work as hard as they do. And they are wary of partners who got their jobs by selling their startups at a big markup and enriching the firm, rather than their business. Founders believe these former entrepreneurs are phoning it in.

This happens, of course, but it's changing. Says Burns: "There is a generational shift under way [in which older partners phase out and younger ones come in]. The partners I know are hustling to try to get the next deal and scrambling to get their name out there to help their portfolio companies."

4. The best VC for your startup is a former entrepreneur.

Somewhat ironically, many founders think that the best venture capitalist for them is a former entrepreneur.

But a former entrepreneur can also view your startup through the lens of his experience and be unable to recognize that what worked for him will not work for you.

"Being a good venture capitalist is not the same as being a good entrepreneur," says Burns. "A good venture capitalist balances encouraging the CEO with giving constructive feedback. And a good venture capitalist must make investment decisions well--which includes cutting losses quickly rather than doubling down on them."

IMAGE: Shutterstock
Last updated: Jun 16, 2014

PETER COHAN

Strategy consultant, startup investor, teacher, corporate speaker, pundit, and author of 11 books, Peter Cohan has invested in six startups, three of which were sold for a total of $2 billion. Before founding Peter S. Cohan & Associates in 1994, he worked with HBS strategy guru Michael E. Porter.




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