WTF Do Venture Capitalists Actually Do?

Venture Capital Industry Overview

  • $250 billion industry that invests in startups like FTX, Theranos, WeWork
  • Type of private equity focused on early-stage businesses vs established companies
  • Venture capitalists are billionaires if they "play the game right"
  • Example: $20 million Alibaba investment became worth $90 billion at IPO
  • One firm started 2009, now manages $18 billion

Private Equity vs Public Markets

  • Private equity: investments in non-public companies
  • Private companies less transparent than public (no quarterly SEC filings)
  • Higher illiquidity = higher expected returns + higher management fees
  • Capital uses: new technology, acquisitions, working capital, balance sheet strengthening
  • Buyout funds: take loans to buy established companies, improve efficiency through layoffs
  • Rescue funds: buy failing businesses cheap, turn around via staff cuts/process improvements

Step 1: Raising Money

  • VCs risk own money + raise from investors
  • Accredited investor requirements (SEC protection rules):
    • $200k income (single) or $300k (married)
    • $1M+ net worth (excluding primary residence)
    • Knowledgeable employee or Series 7/65/82 license
  • Target investors who can write $10M checks casually
  • Can bypass rules through pension fund middlemen
  • Average people protected from risky investments they don't understand

Step 2: Finding Investment Opportunities

  • Money funds businesses from idea to reality
  • Most businesses fail even with VC backing
  • Strategy: make many small bets, hope 1 in 100 generates 1000x returns to offset 99 failures
  • Due diligence straightforward for early-stage (no formal operations to audit)
  • Standardized share purchase agreements used

Deal Sourcing Challenges

  • Open pitches = waste time on bad ideas from unqualified founders
  • Too narrow search = miss billion-dollar opportunities to competitors
  • Build relationships with colleges, incubators (Y Combinator, Techstars)
  • 2021 startup gold rush: VCs marketed as thought leaders to attract founders
  • Low interest rates = hard to find enough promising businesses for available money

Payment Structure & Incentives

  • Paid based on assets under management + fund performance
  • Performance less important than fund size
  • Can raise new funds while deploying current fund money
  • Incentive to invest in any justifiable business
  • Early-stage risk makes failures hard to blame on VCs

Step 3: Scaling the Business

  • VCs secure board seats, maintain founder communication
  • Money spent on product development + customer acquisition
  • Customer growth + product development drive higher valuations (even without profit)
  • VCs fought to give money to promising ideas (opposite of Shark Tank)
  • Some VCs stopped due diligence to speed up deals vs competitors

Market Shift & Fraud Issues

  • "End of Faking It in Silicon Valley" - pendulum swinging from easy money/wild valuations
  • Culture of embellishing numbers, over-promising features
  • VCs supported behavior - difficult to distinguish optimism from fraud
  • Early-stage VCs dumped positions to later investors before problems discovered

Notable Fraud Cases

  • Charlie Javis (Frank): 100 years prison for fake user accounts
  • Rishi Shaw (Outcome Health): guilty of defrauding customers/investors
  • Trevor Milton (Nicola Motors): convicted fraud, up to 25 years
  • Sam Bankman-Fried (FTX): 100+ years potential for crypto exchange collapse
  • Elizabeth Holmes (Theranos): 11 years prison for investor fraud/falsified medical results

Step 4: The Big Exit

  • Sell to institutions for long-term holding or public markets via IPO
  • Stricter rules at exit stage
  • Investment bankers specialize in company exits
  • VCs promote successful companies to attract investors + startups
  • Risk: embarrassing old tweets/newsletters if frothy positions dumped on late-stage investors/public

Business Planning Resources

  • HubSpot business plan template mentioned
  • Helps create effective pitch, business model, market understanding, profitability path
  • Free resource for entrepreneurs and side projects