As many as 75 percent of venture-backed companies never return cash to investors. Here is how to improve the odds with better execution.
BY FAISAL HOQUE
In a recent Wall Street Journal article, Harvard Business School senior lecturer Shikhar Ghosh shared that the prevalence of failure in the world of venture capital is much higher than what’s reported.
Ghosh’s research indicates that as many as 75 percent of venture-backed companies never return cash to investors, with 30 to 40 percent of those liquidating assets where investors lose all of their money. His findings are based on research of more than 2,000 venture-backed companies that raised at least $1 million from 2004 to 2010.
Unfortunately, I’m no stranger to those statistics. In the late ’90s, I founded EC Cubed, a B2B e-commerce software platform company. Like many other founders, the proverbial door hit me on the you-know-what at the hands of the VCs who invested $50 million to rapidly grow the company. While that was extremely difficult, what was even more painful was watching the company collapse soon after my departure, despite the capital infusion.
Such tales are rarely bragged about. In fact, Ghosh tells the Journal that VCs “bury their dead very quietly.” The deceased are quickly removed from the portfolio companies section of websites, never to be spoken of again.
The success rate of private equity firms isn’t much better. Money doesn’t guarantee success; only effective execution can deliver that goal. I believe improving the odds for venture-backed companies requires better execution.
It goes without saying that private equity investments aren’t for everyone. Reaping mega rewards means taking mammoth risks, and PE investments often demand long holding periods for the turnaround of a distressed company or a liquidity event such as an initial public offering or a sale to a public company. Private equity firms invested more than $144 billion in 1,702 U.S.-based companies in 2011, according to an analysis by the Private Equity Growth Capital Council. Some of the biggest investors in the PE market are public pension funds, many of which have seen sub-10% returns.
Creating value from any venture is hard work and much has been written to document the challenges of entrepreneurial journeys for those preparing to set out on their own passage.
I used the term “odds” earlier to draw upon the analogy that more times than not, the strategy employed in the investments made closely resembles that of gambling–or, for those who are more innocent, wishful thinking. A play on probability: The theory that in a numbers game, some will win and some will lose, is not an acceptable approach, especially when fund managers’ fees can reach in the millions while investments may result in massive losses.
Read the full article @FastCompany.
[Image: Flickr user Jon McGovern]