Love your HBS stuff Michael. First time I have seen a VC lecture about entrepreneurship with very valuable content for the entrepreneurs.  It is great to see a VC talk about the limits and problems of the venture capital industry. To me their downfall is mainly due to no operating experience running a company. I believe there is data that the firms with experience operating managers (i.e. Marquette) do far better but forget the source of that.

As a CEO since 1989 I can model, or simulate, an entire business model in my head with sales, marketing, finance, operations and product development. I can handicap each risk based on real-world experience and adjust or build in backup plans. I can quickly detect problems. often before they happen and correct course. This mental ability to “mentally simulate” and see the future well comes only from decades of experience operating companies.

VCs have their checklist of reject signals but have little ability to understand the upside beyond “Market size”. They fail to see barriers to entry that evolve over time and are not totally obvious like patents. Often complexity of execution combine with excellence in management can be a huge barrier created by a high-performance culture and there are many, many others.  They have many “rules of thumb” that do not apply all the time, but they cannot see beyond that rule because they do not understand why it is a rule.

Today most VCs even refuse to take risk and invest in something without traction, when they are in the risk business. Seed stage is where the 50-100X upside is but their ability to judge deal quality is so poor most cannot succeed in this area.  This is because they cannot see around the corner, even a few months away while experienced CEOs and Entrepreneurs can see years out. They are building a company for a future world, one to five year out, not for today. This is this handicap that gives the average VC an 80% failure rate and penalizes the best Entrepreneurs with the 40% IRR needed to make up for this large percentage of failures. Smart Entrepreneurs do not want to pay for dumb Entrepreneurs – or anyone else’s failures. So, they opt-out of using venture capital firms and find other sources of money or bootstrap. Hence, the industry is slowly collapsing due to poor returns and a lack of understanding of these issues.

Venture capitalists need to get back into the seed business with $100K – $250K deals, not just $10M-$100M deals which used to be called “mezzanine”, the last funding before an IPO. Now they do Series X, Y and Z deals. That is not venture capital, but expansion financing of a proven concept.

Venture capital firms need an EIR on staff always, looking at all deals. It can take a week or two of work to analyze a good deal, but this can bring the risk to maybe 50-50 instead of 1 in 10. It is near impossible to get the risk lower because of unknown competitors and other market surprises. However, the experienced CEO/Entrepreneur has a plan to adjust or will come up with one quickly. They will have built their core value proposition in a way that allows a pivot without a total rebuild. Every dollar will be invested in a way that it can be monetized later with many different business models.  Venture Capitalists just lack the understanding to do this work themselves.