I recently read The Secrets of Sand Hill Road by Scott Kupor which is about venture capital and how to get it. Scott does a really good job explaining the in and outs of venture capital. The book is very easy to digest and also provides a lot of really great insight into the black box of venture capital.
The Secrets of Sand Hill Road Nitty Gritty
Scott works at Andreessen Horowitz the famous venture capital firm and was their first employee. Andreessen Horowitz famously invested in Instagram, Airbnb, Facebook, Lyft, and Zynga, among others. As such, they are very well respected in Silicon Valley and beyond. Sand Hill Road, for those that don’t know, is a famous road out in Silicon Valley where the big-name venture capitalists have offices.
I highly recommend this book if you are a founder or interested in venture capital. The Secrets of Sand Hill Road goes into great detail about the industry and is easy to digest. You’ll see sides of VC that you wouldn’t normally think about. With that, there were three main secrets that are important to understand about venture capital.
The Promises Venture Capitalists Make
First is thinking about the incentives and promises that the venture capitalists have made to their investors. Venture capitalists are using other people’s money to fund startups. Yes, they usually have some of their own money in the funds. But at the end of the day, the majority of that money is actually from other large investors.
Who are those investors?
Those large investors could be college endowment funds, pension funds, and even hedge funds. They invest with VCs because they are looking for an outsized return on investment. With the money provided to the VCs, there are certain terms and expectations that come with that money. The money isn’t for them to go have fun with and gamble away on any company.
There are certain criteria for each fund. There are certain time horizons for returning capital, certain barriers in terms of what the venture capitalists are allowed to invest in, and guidelines on expectations that each VC fund has.
Understanding the nuances of a fund is important when thinking about who you should target as a possible investor. The key nuances are knowing the age of the fund, how much capital it has to deploy, the VCs track record, and the types of investments the fund can make. Thus receiving money from a recently raised fund versus a fund at the end of life, really matters.
Fund Age May Affect Relationship with a VC
For example, if you are one of the first companies that receive investment you have a longer time horizon for when that fund is supposed to return capital back to its investors. That can lead to less pressure from the venture capitalist to push lightening growth.
Whereas if you receive funding towards the end of the fund’s life, there is less time between when the VC is supposed to return the money to investors. This could lead to expectations to quickly return capital and quickly grow. That pressure for fast growth may or may not be suited for where your company is at the time. This is one very important secret of Sand Hill Road.
When I was first starting to have conversations with venture capitalists I didn’t think about this hidden incentive. While I was aware that there were various funds, I didn’t understand what information was important to pay attention to beyond being in the right category. All I knew was that certain VC’s invest in certain categories and stages of companies.
Be sure to really understand the incentives and time horizons that VCs have with their investible funds.
Beyond Valuations. Understand the Term Sheet
The second insight is that oftentimes founders get stuck on the valuation. How much equity am I giving away? What’s the dollar value? These are all the classic questions that most folks focus on without really thinking about the terms of the investment.
Luckily Scott goes into great detail about the term sheet. The term sheet highlights exactly what those other riders are. It spells out how things will be held, how the board will be controlled, and how capital is returned on the next round (of investment).
This is where venture capitalists have a larger advantage over founders as they have more experience laying out the how of the investment.
In The Secrets of Sand Hill Road, there is a comparison of two term sheets. Walking through that example shows how the valuation is merely one small part of partnering with a venture capital firm. Usually, you don’t think about or discuss all of the terms until after you’ve received a term sheet. Go beyond the valuation when taking on venture capital.
Private is the New Public
And then the last thing that I found really interesting is that companies are staying private a lot longer than they have historically. It used to be that companies would IPO, meaning they would do an initial public offering to become publicly traded on a stock exchange. It used to be about five years on average. During the dot-com bubble that average was even less. It is now closer to ten years.
You may be thinking, “so what?”
Hedge funds, college endowments, and retirement funds used to buy companies when they IPO’d, but that has changed. At some point, the investment shifted earlier. The result is companies that normally would have to go public to raise large sums of money, don’t have to anymore. This means that companies are staying private longer because there’s so much more money in the private markets.
That also means that these institutions are now chasing those returns forward. So they’re getting into venture capital to invest pre-IPO. It has resulted in a feedback loop.
These are just some of the nuances of how venture capital and the capital markets have changed.
Wrapping up the Secrets of Sand Hill Road
I recommend entrepreneurs read this book. It’s great in terms of understanding venture capital investors. It is important to note that venture capitalists aren’t exclusively in technology, software, and hardware. They invest in a lot of other categories too.
Overall it’s a very simple, easy to digest book that will give you a great perspective on venture capital and the incentives behind it, which will help you as a founder.