One thing that non-VCs typically don't have a good understanding of is how different venture investors view the risk versus reward tradeoff when it comes to managing portfolio companies.
How do VCs get compensated, besides salary? "Carry", a/k/a profit-sharing. And except in very few cases, carry on an entire fund, not on a per-deal basis. Everyone in the industry is familiar with the studies that have shown that fund performance is typically determined, at least on the upside, by a handful of deals across an entire portfolio. In other words, 1 or more really big wins drive all the performance. And, by the way, 1 or more really big wins really drive a VC's career as well, because of the visibility they bring.
It all sets up a dynamic where individual VCs, and overall partnerships, are motivated not to try to produce steady returns across an entire portfolio, but instead to try to maximize the slim chance that each deal becomes a blockbuster.
Let's put some really oversimplified math to it:
$100M fund, 10 portfolio companies, each with $10M committed. If each one creates a 2x outcome, that's $100M in return. But if just one company creates a 10x outcome, then you could only break even with all the others and still come close to creating the same return ($90M). If you get two 10x outcomes, or one ten-bagger and one 5-bagger, then the VC fund is sitting pretty almost regardless of what anything else in the portfolio does.
This has a lot of implications for how VCs typically manage their portfolios. To overgeneralize a bit:
First of all, it explains why VCs would so often pass on investment opportunities with good chances to double or triple their money. Not that any one as an individual would pass up on the opportunity to double or triple their own money all things being equal, but if you're more motivated to find the 5-10x opportunities you'll pass up on attractive but smaller ones. I interact with entrepreneurs all the time who have good solid businesses with good growth prospects, and yet they're frustrated at their inability to get VC interest. Basically, this is one major reason why that happens.
Secondly, it means VCs will spend more time on their portfolio companies that are doing well, versus the companies that aren't doing well. If they can help turn a 3x outcome into a 10x outcome, that's worth a lot more to them than working hard to turn a 0.3x outcome into a 1x outcome. Many VCs I know have a hard time sticking to this rule, because at the end of the day as individuals with personal relationships and a sense of obligation they want to help out all their companies as much as possible, but the more hardnosed VCs will admit that this is how they try to spend their limited available time in portfolio management. I've even heard of some big-name VCs who simply stop showing up for board meetings once the company gets off-track.
Thirdly, it means that around the boardroom, many VCs will tend to push their companies into riskier situations when it means a better likelihood of an upside outcome. Let me illustrate:
If the VC starts out with each company having a 30% chance of a 0x, a 30% chance of a 1x, a 30% chance of a 2x, and a 10% chance of a 10x, then if they can shift that to be 50% chance of a 0x, 15% chance of a 1x, 15% chance of a 2x, and 20% chance of a 10x, that can end up being a better odds-weighted return.
But note that, to the entrepreneur, that just became a much riskier scenario.
How does this play out in reality? Well, the other day someone was telling me about one cleantech company with two big-name generalist VC firms as investors. And they were describing how, around the boardroom, there had been major disagreement between the two VC firms -- one wanted the company to be burning several hundred thousand in cash per month, the other wanted the company to be burning more than a million in cash per month. With the real disagreement being around how quickly to push the company to bring a commercial product to market. This is a natural outcome of all of the motivations described above, along with an expectation that one way or another these brand-name VCs could attract additional follow-on capital into the company if and when it ran out of cash.
On the other hand, I know that many of the "original cleantech crew" of sectoral specialist VCs, and some other specialist and generalist VCs with lower-risk approaches, tend to want the companies to get to cashflow breakeven as quickly as possible. And thus they want to keep the company expenses lean.
I typically favor that last approach (albeit on a case by case basis). I just think in slow-moving cleantech markets, rushing a product to market doesn't have the same likelihood of creating customer uptake and first-mover advantage as is often seen in other technology sectors. So you can easily put a company in a high cash burn situation to successfully bring a product to market, and still fail. Venture capital is risky enough, without adding further risk into a company...
But no one knows which approach is truly best for producing investment returns. In the boardroom anecdote above, those investors were deeply experienced and VC-savvy (certainly more so than me), and not dumb about cleantech either. And until we see a wave of exits, no one in this industry will have proven that they know how to consistently make money. So the right risk/reward tradeoff approach to cleantech venture investing remains a very open question.
However, to those out there urging that major amounts of government dollars be simply handed over to VCs to invest as they see fit... Make sure you really understand and are comfortable with all of the above dynamic, and what its implications would be for the successful commercialization of a broad range of clean energy and other technologies. I am absolutely a strong proponent of government support for commercialization of clean technologies. But not as a carte blanche to VCs...