Professor Raiton’s Inside Perspectives: Entrepreneurship, Creativity, Innovation

From Get Venture by Mark Davis

As I mentioned in my post, The Market For Venture Capital, there are two markets that exert pressure on VC return requirements.  The first market is the market for investable capital. The second market is the market for investments, where VCs jockey to get money into startups and vice versa.

One force in this market is simple supply and demand.  If there are lots of VCs bidding for a startup, the terms of the eventual investment are likely to be more favorable to the entrepreneur.  Similarly, if there is only one VC interested the terms are more likely to be favorable to the VC. 

Additionally, substitution plays an important role in this market.  If there are lots of great startups chasing a number of financiers, a VC may be able to get a better deal. 

Another way of looking at the market is the risk-return ratio.  Investing in startups is an inherently risky business, even for investors with a good eye.  There are lots of exogenous risks that might undercut a perfectly reasonable venture along the way.  Nothing shocking here - VCs need to own enough of the company to ensure that they are compensated for the risk they are taking - higher returns are required to offset the high risk of losing everything.