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

From Get Venture by Mark Davis

In my prior posts about the market for investable capital and the market for investments I described two markets in which VCs must operate.

While each market has independent forces that drive valuations, they are also interrelated. When you think about the market dynamics in the market for investments that drive fluctuations, it’s important to realize the role of the market for investable capital. VCs need to generate returns that are competitive with other alternative asset classes (e.g., hedge funds and leveraged buyout shops). In order to generate sufficient returns, they have a minimum threshold on the valuation that they can accept in their investments.

There are a few implications of this minimum.

• First, creating favorable negotiating dynamics can impact valuation, but only by so much.
• Second, the comment that VCs generally take too big a cut in a transaction reflects a lack of understanding of the underlying cost of capital - the next best option an institutional investor (who invests in VCs) has in the alternative asset class.