Can’t say too much, but let’s just say I have had some exposure to venture capital firms. At one time, I wanted to RUN a venture capital firm. Might still do that one day. But, interestingly, what I have discovered through this “exposure” is that what you think their business model is… and what their business model really is… may be two different things.

Here’s what I mean. A venture capital firm seemingly raises funds from various kinds of investors – private investors, fund managers, etc – for specific investment funds. Those funds are invested in high potential, start-up companies. Within a given period of time e.g. 5 years, the venture capitalists (VCs) typically expect to sell their shares to an acquiring company (known as a “trade sale”) or to the public via an initial public offering (IPO). As such, they only seek to invest in companies that are likely to provide a big payout via such a trade sale or IPO.

That’s the apparent VC business model. But here’s where it gets a little complicated. You see, if you’re one of the investee companies you could be forgiven for thinking that the VCs do in fact seek to make money from selling their shares in your company via a trade sale or IPO.

But guess what? That may NOT be how they seek to cash out at all. They may, in fact, be using your company in other ways… not necessarily to make money from selling your shares. They may want to sell or merge you with another entity, or “back door” you into a public entity, or use you in a host of ways that doesn’t necessitate that your company makes any money or that the sale of your company makes any money. They may be quite happy skimming off “management fees” and “finder fees” regardless of how much your company makes in sales or profits, or is worth.

Don’t get me wrong. The main game for VCs is to cash out, make an enormous profit, and reinvest in other startups. But they have a holistic perspective. They think in terms of making money for the fund as a whole, not individual companies.

Why am I speaking about this? Because it’s important for investee companies not be deluded into thinking that their interests are necessarily aligned with those of their investors, particularly venture capital firms. I am NOT saying that VCs are “bad” – I’m just saying that their agenda is to make money for their investors.

For VCs this can actually create a conflict of interest – especially if they sit on investee company boards. How do they fulfil their duties to the company… and their duties to their investors? An interesting question for legal minds.

But for companies seeking venture capital – and again, I’m totally SUPPORTIVE of this – be aware of the “real game” that the VCs are in. That way, you can better protect yourself and avoid being disappointed.

This entry was posted on Friday, August 1st, 2008 at 8:58 pm and is filed under Feature, Venture Capital. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.