Successful founders of venture-capital-backed startups are more likely to become venture capitalists (VCs), and are more likely to succeed as VCs, Paul A. Gompers and Vladimir Mukharlyamov find in Transferable Skills? Founders as Venture Capitalists (NBER Working Paper 29907).
The researchers collect data from 1990–2019 from VentureSource and Thompson Financial on the identities of startup founders and VCs as well as information on dates of investments, amounts invested, each startup’s industry and location, and each portfolio company’s ultimate outcome. They also collect biographical information from a wide range of sources about founders and VCs, including past work experience, educational history, ethnicity, and gender.
Founders of successful startups who become VCs have higher success rates on their investments than professional VCs who are not founders.
The researchers define success for both founders and VCs as having a startup or investment that goes public or having a startup that is acquired for a value higher than the total amount of capital invested. Success as a founder is a significant factor in determining who becomes a VC. Almost 7 percent of VCs in the sample — 825 out of 12,195 — had founded a venture-capital-funded startup. Nearly 30 percent of these startups were successful, while about 12 percent were unsuccessful.
Members of privileged groups are also more likely to move from founding a startup into venture capital. Being male makes this more likely. Almost 12 percent of founders are women, but only about 5 percent of them become VCs. Nearly 85 percent of founder-VCs are White. There is a smaller percentage of racial and ethnic minority group members in the sample of founder-VCs than there is in the pool of founders. Finally, attending one of 17 colleges defined by the researchers as top schools also increases the probability of a founder becoming a venture capitalist.
The researchers divide their dataset into three groups: successful startup founders who became VCs, unsuccessful founders who became VCs, and professional VCs who were not previously startup founders. There is a clear progression of success rates among them. Successful startup founders have the highest success rates on their VC investments, nearly 30 percent. They are followed by professional VCs at just over 23 percent, and unsuccessful founder-VCs at just over 19 percent. About one in every eight successful founder-VCs’ investments exit via an initial public offering; fewer than one in 10 professional VCs’ investments exit via an IPO, and only one in 14 unsuccessful founder-VCs’ investments exit via an IPO.
On average, successful founder-VCs make more investments (6.7) and have longer careers (12.2 years) relative to both professional VCs (5.8 investments and 11.5 years) and unsuccessful founder-VCs (4.9 investments and 9.6 years).
Some of the successful founder-VCs’ achievements are the result of their joining venture capital firms with higher success rates. Another contributing factor is their ability to add value to a startup after investing. The researchers speculate that added value may be attributable to a “halo effect,” through which potential future investors, customers, or employees view a startup more favorably because a successful founder-VC has invested in it. Successful founder-VCs may also add value by being accessible to employees and board members, or by offering advice and guidance based on knowledge of the startup’s industry. Investments by successful founder-VCs in the industry of their startup are nearly 6 percent more successful than investments by professional VCs.
— Brett M. Rhyne
FAQs
Using the VC method, the value of the target entity is estimated as the value after a few years (the so called 'exit-value'). That value is then discounted to the present value using a discount rate. The DCF method is used for companies where cash flows can be reasonably estimated.
What is the main problem with using a venture capitalist for a startup company? ›
Depending on the size of the VC firm's stake in your company, which could be more than 50%, you could lose management control. Essentially, you could be giving up ownership of your own business.
How do venture capitalists help startups? ›
They provide strategic guidance, sharing industry insights and best practices to help the founders navigate challenges. Connecting startups with potential partners, customers, or key hires, venture capitalists play a crucial role in expanding the startup's network.
What do VCs look for in founders? ›
Venture Capitalists highly value prior industry experience in Founders they choose to back for several reasons. Industry experience equips Founders with a deep understanding of market needs, customer pain points, and the competitive landscape, enabling them to better navigate complexities and opportunities.
Why do venture capitalists invest in startups? ›
New businesses are often highly risky and cost-intensive ventures. As a result, external capital is often sought to spread the risk of failure. In return for taking on this risk through investment, investors in new companies can obtain equity and voting rights for cents on the potential dollar.
What is a startup vs venture capitalist? ›
Startups must continually raise capital for the lifespan of their company, from pre-seed to IPO. In contrast, VCs secure capital once per fund, which lasts for years.
What is the weakness of venture capitalist? ›
The primary disadvantage of VC is that entrepreneurs give up an ownership stake in their business. Many a time, it may so happen that a company requires additional funding that is higher than the initial estimates.
What are the dangers of venture capital? ›
Venture capital is a high-risk, high-reward type of investment, and there is no guarantee of success. While VC firms aim to identify the best opportunities and minimize risk, investing in startups and early-stage companies is inherently risky, and there is always the potential for loss of capital.
What is the most challenging part of venture capital? ›
Economic downturns are one of the biggest challenges venture capitalists face. A recession in a certain sector may cause investors to be cautious with their funding, which can make it difficult for a company to grow and expand.
How to support founders? ›
Be authentic and be there for them when they need you, especially when they don't know how to ask. Founders truly treasure those who are supportive and understand the demands of their chosen path.
The capital in VC comes from affluent individuals, pension funds, endowments, insurance companies, and other entities that are willing to take higher risks for potentially higher rewards. This form of financing is distinct from traditional bank loans or public markets, focusing instead on long-term growth potential.
What do venture capitalists want to accomplish? ›
Key Takeaways
Venture capitalists (VCs) are known for making large bets in new start-up companies, hoping to hit a home-run on a future billion-dollar company. With so many investment opportunities and start-up pitches, VCs often have a set of criteria that they look for and evaluate before making an investment.
What questions do VCs ask founders? ›
Founding Team:
Are you 100% fully committed to making your idea a success? How has your previous experience helped you? How do you deal with conflict of interest? How do you approach goal setting and KPIs?
What is the success rate of venture capitalists? ›
There is a clear progression of success rates among them. Successful startup founders have the highest success rates on their VC investments, nearly 30 percent. They are followed by professional VCs at just over 23 percent, and unsuccessful founder-VCs at just over 19 percent.
How do investors evaluate startups? ›
Venture Capital Method
Venture capitalists commonly use this valuation approach to assess startups' worth. This method focuses on potential return on investment (ROI), future cash flows, exit strategies, and risk assessment to determine a startup's valuation.
How do startups value their company? ›
The market approach involves using available data from comparable transactions or comparable companies as a basis of comparison for the startup. In this approach, you will blend your company's financial performance (and/or projections) with market data, such as trading multiples, to infer the value of your company.
What is the WACC of a startup? ›
The “Weighted Average Cost of Capital” (WACC) refers to the cost to a company of obtaining financing both from investors in the form of equity, and from banking institutions in the form of debt or other banking instruments (e.g. bonds).
What is the average WACC for startups? ›
What is for Startups WACC %? As of today (2024-05-19), for Startups's weighted average cost of capital is 6.32%%. for Startups's ROIC % is 28.93% (calculated using TTM income statement data). for Startups generates higher returns on investment than it costs the company to raise the capital needed for that investment.
