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The paradox of new venture investing

Hoi mede-HLers,


Vond zojuist op een ander forum onderstaand artikel dat ik met jullie zou willen delen. Overigens heb ik van de auteur Gerry Lemberg toestemming gekregen om het artikel te publiceren.




Throughout Europe only two out of a hundred new venture business plans written with the objective of raising seed finance succeed in doing so. Yet all investors, from business angels to large-scale investment houses report a shortage of worthwhile projects. We can cite a number of possible reasons for this seeming paradox.


From the Entrepreneur’s Perspective

- Hostility toward VC’s and private investors by entrepreneurs who rightly or wrongly believe that they are too risk adverse and/or greedy.

- The comparative naivety of many entrepreneurs to the venture process.

- The inability and lack of urgency of many entrepreneurs to overcome their ignorance of the process.

- An orientation toward generating new ideas rather than concentrating on the process of executing them.


From the Investor’s Perspective

- Punishing terms in investment agreements

- Opacity of the system

- A short-term view toward exit

- Vigour in turning the funding tap on and off according to their perceived view of the state of the “cycle”.


Added to the clash of these two perspectives, is that success in the venture capital industry is defined by the size of the capital fund they are managing. The large size of the fund under management determines the minimum size of any investment they are willing to make. in many cases, the end of this clash, results in a misjudgement at both ends; overinvestment at the top end followed by underinvestment at the bottom of the “cycle”, results in starving the future stars.


One of the most urgent challenges is how to furnish effective seed financing to the upcoming stars irrespective of the phase of the “cycle”. If seed financing is not available, the whole chain of building new businesses breaks down.


The Ecosystem


The ecosystem of new venture funding is the same as any other successful business. At one end there has to be a R&D function. In the equity investment business this is referred to as “seed funding”. At the other end there is sale and delivery function of the product. In the equity investment business this is referred to as the exit. Does any successful business totally outsource their R&D? Many of the major venture capital firms do exactly that by placing a minimum of several millions to any deal in which they will invest.


One of the major risks to this approach is that if they find a venture that excites them, they will over invest to the point that the entrepreneurs believe they are in “financial heaven”. These new ventures are easily identifiable. If you look in their car parks you will find an assortment of top of the line luxury cars. If you look at their marketing and sales plans, you will find large budgets for advertising, promotion and PR being spent to try to establish a brand before anyone has figured out whether their product or service is properly positioned within their industry and market space. The “Internet bubble” is the monument to the carcases that have littered the landscape over the last few years, caused by overinvestment in these start-ups.


In earlier days of the venture capital industry, the VC’s were staffed by entrepreneurs who had either started new companies or worked at pioneering high tech companies. They actually had staff and analysts who experienced the rigours and the ups and downs of executing a new idea and generating revenue with it by bringing it into a competitive marketplace. The VC staff had operational wisdom that resulted from their real life experience of operating companies. The VC’s seeded them and fleshed out their ideas so they could be implemented. The results were sustainable companies like Intel, Apple, Electronic Arts, Microsoft, Oracle, Cisco, Yahoo and many others.


Today, most VC’s are staffed by investment bankers armed with an MBA and a few years experience as bankers and/or analysts whose experience is limited to characterising established public companies or doing M&A or MBO’s. These VC’s have all the skills required to do a profitable exit, if they have the raw material with which to work; however, they generally lack the skills to evaluate or help a new venture go through its growing pains toward growth and profitability. In most cases though, they have a “Finance Director”, usually with no specific understanding of the business, who can go in and find ways to “save money”. That’s always the first step to liquidation.


At the other end of the feeding chain for new venture investment are:


- Family, Friends and Fools

- Government Funds

- Banks

- Business Angels


The common problem with all these sources of finance is under investment. Where the VC has a minimum investment per venture, the above sources usually have a maximum investment per venture. If early seed stage investors under invest in a new venture, the entrepreneur is in the position of having to spend a significant amount of time chasing further investment at the expense of building the business. In effect, under investment is essentially funding the time to find further funding, creating a vicious circle of constantly chasing your tail. Is it any wonder that such a high percentage of new ventures fail?


The Entrepreneurs


Since we seem to live in a “blame culture”, each side of the entrepreneur/investor tango blames the other for their failures. How many times have you heard budding entrepreneurs describe VC’s or other investors in the following manner?


“Those arrogant bastards…”


”When they actually had some money to invest, it was rude enough to demand that some poor, struggling entrepreneur condense his dream's entire raison d'etre into a microcosm lasting no more than an excruciatingly brief ride up or down in a vertical people lifter. Now, with no life's blood money to dispense, it's positively cruel and inhumane.”


”How can any human being treat others in such a condescending, patronising manner and expect to be liked? Or respected?”


”The "little guys"--the wild-eyed entrepreneurs chasing their business envisagement-are the true engines of any economy by providing jobs, healthcare and other benefits, taxes for government, and money for vendors, partners and consumer spending. These adroit, ingenious individuals and strike forces are indispensable to the remainder of the world.”


The Investors


How many times have you heard investors describe budding entrepreneurs in the following manner?


“Those propeller heads, they can’t even compose a compelling 2 page summary of their business plan. How do they expect us to react?”


“Our valuation is based on the risks we are taking in backing an unproven team with what could be a great idea.”


“If they can’t even find out my name or our investment space before sending me an unsolicited business plan, why would they expect me to read it?”


“Get back to me when you have a proof of concept and a customer who will buy your product.”


The Real World


In reality, any venture will be compelling and funded if it offers a solution to a well defined business problem that will generate revenue when executed by a highly motivated team of entrepreneurs possessing an “unfair advantage”.

Potential Solutions to the Paradox


Without the right kind of seed financing, the entrepreneur/investor tango always becomes adversarial rather than a partnership. Given the structure of the investment industry and the character of its players, the solution lies in collaboration among the players at the very early stages. A number of alternatives can be considered.


- The VC sector of investment industry can effectively outsource their R&D to business angels and specialised intermediary consulting services. By establishing a seed fund in conjunction with intermediary consultants and universities with strong technology departments and/or MBA programmes in Entrepreneurship. This private-public partnership could be the breeding ground of a continuous source of new business opportunities with the mentoring and coaching on-site to assure a smooth transition to later stages of financing.


- The formal collaboration can be set up between Business Angel Networks for seed and early stage financing and VC’s for later stage financing. Without a formal collaboration agreement, business angels will always be concerned about being crushed by the VC’s in the later stages. An understanding at the front end of the funding process based on achievable milestones will greatly reduce punishing terms in later stage financing rounds.


The entrepreneurs also need to take a more realistic view toward the funding process. Most of the 98% of the new ventures that don’t get properly funded are due to:


- A belief that an idea or a technology development by itself is sufficient grounds for investors to beat a path to your door.

- An inability to understand the difference between an idea and what it takes to execute that idea into a revenue-generating business.

- The ignorance of not recognising that the funding process is structured to mitigate stupid risks and flesh out the criteria for success.

- The lack of communication and presentation skills.


Entrepreneurs also have to recognise that the funding process is also a business and requires skills that are in the same class as other professional services; therefore, they can’t be offered pro bono any more than any other professional services. When was the last time a physician, lawyer or accountant agreed to accept their fees subject to success criteria only? Fees and terms for fund raising can and should be negotiated. Raising finance for a new venture is also highly dependent on the entrepreneurs as well as the intermediary professionals.

Therefore any belief that the intermediary’s services in financing new start-up ventures can be compensated only by a success fee is not a reasonable expectation.


Until entrepreneurs attach some urgency to repair their ignorance of the tango required to negotiate funding from the investment community, they will continue to find hostility in that industry. The investment industry’s primary role is to earn a return for their investors, rather than fuel entrepreneur’s egos. The spirit of partnership between the entrepreneur and the investors that has characterised the US venture capital industry for much of its history, has been a crucial ingredient in past successes. The deal-centric banking mentality at the heart of the European way of doing things can constitute a considerable obstacle to progress.


The European investment community needs to work on creating and smoothing out the links in the virtuous links of success. This circle is where the best entrepreneurial teams attract the best investor teams who can open doors to the best suppliers, customers and intermediaries to build sustainable and successful companies.



About the author


Dr. Gerry Lemberg is Chairman of Silver Fox TeroVentures


Silver Fox TeroVentures offers both entrepreneurs and investors an opportunity to enter into the world of TeroVenturing. TeroVenturing is defined as a branch of the investment community that combines management, financial and technical expertise to efficiently analyse, plan and move a business opportunity to create a business model, plan and funding package to create and realise wealth all the stake holders… the investors, entrepreneurs, employees, suppliers and community over the life of the company.


Met vriendelijke groet,




[titel in kleine onderkast gezet, dat oogt wat sympathieker - mod]

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