Venture Capitalism: Problems and Risks

This article is an excerpt from the Shortform book guide to "Blitzscaling" by Reid Hoffman and Chris Yeh. Shortform has the world's best summaries and analyses of books you should be reading.

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Should you work with a venture capitalist to grow your startup? What are the main problems associated with venture capitalism?

When the stars align perfectly, working with a venture capitalist can be exactly what you need to get your business on its feet. However, raising funding through venture capitalism is not without problems. If you’re looking into a VC, consider these risks first.

Continue reading to learn more about venture capitalism problems.

Why You Should Be Careful With Venture Capitalists

Reid Hoffman, the author of Blitzscaling, spends part of his time as a venture capitalist. Much as with Peter Thiel’s Zero to One, be aware of the incentives venture capitalists have to push the “take huge risks, move fast at all costs” narrative, and how these incentives might conflict with yours as a founder:

  • VCs need outsized returns on a few companies to make up most of the returns of their entire portfolio. They’d prefer for each company to go for broke than to be conservative – for a VC, it’s ok for 9 companies to fail if 1 is a blockbuster. In contrast, you only have your one company, and another company’s success is little condolence when yours fails.
  • VCs need to deploy large amounts of capital if they raise large funds (e.g. if they raise a $1B fund, they can’t write $1MM checks). For you, raising more capital may not be worth the dilution and liquidation preferences if you can’t effectively deploy the capital.
  • VCs raise funds with a limited lifetime (usually 10 years with extensions) and need to get liquidity for their equity in your company during that time (sell stock, IPO, acquisition). They therefore want to push for fast growth and exit sooner. If you prefer a longer time horizon or want to stay private forever, your interests may conflict.

In many cases, VC performs a valuable function when the stars align. In a superb case like Facebook, everyone’s incentives were aligned—the business actually needs capital to grow in a winner-take-all market, the strategy thesis is correct, the business effectively deploys capital, and the company explodes in value.

In the most punishing case of venture capitalism problems, your market doesn’t have huge returns of scale or winner-take-all dynamics, you raised too much capital to burn on strategies that don’t return, and liquidation preferences for investors sap your returns on exit. In an alternate universe, you might have built a more sustainable, meaningfully successful company and pocketed more returns.

Venture Capitalism: Problems and Risks

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Hannah Aster

Hannah graduated summa cum laude with a degree in English and double minors in Professional Writing and Creative Writing. She grew up reading books like Harry Potter and His Dark Materials and has always carried a passion for fiction. However, Hannah transitioned to non-fiction writing when she started her travel website in 2018 and now enjoys sharing travel guides and trying to inspire others to see the world.

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