Psychology behind why Venture Capital exists…

A lot of folks try to understand venture funding without understanding why it exists in the first place.

Venture funding (provided by VCs, Angels, Family Offices) is where most people go for capital to grow their startup - but why? Some might say who cares, but understanding why will help you better understand the psychological motivators behind investors.

If you wanted money for most things in life (school, house, car) you’d go to a bank or credit card - but why not for new companies? Well, it has to do with asset values and timing. Usually with a house or car, there is an underlying asset with a current value that lenders can materialize and measure. A new startup, however, has little to no current asset value, but may have tremendous future value which, of course, is uncertain.

This creates a naturally an underserved gap in funding that is caused by a lack of data or information to assess an investment. In other words, in insurance or banking terms, there is not enough data to underwrite the risk of investing in early-stage ventures. This is why banks typically won't provide SBA/SBR loans (loans given by the government to small businesses), and private equity steers away. How could they do proper due diligence to assess the risk when you are pre-revenue or even pre-finished products?

On the other hand, founders either don’t have the appropriate resources to scale a venture on their own or don’t want to take all of the financial risks to self-fund the venture.

Thus the need for early-stage funding arises in order to fill the gap. Otherwise, innovation will only happen for wealthy individuals or large corporations. So for investors, this is all about turning today’s future value into materialized, current value (in the future).

With this knowledge, prudent founders will focus more on what will get investors interested: a large future value with a clear execution strategy. Forget the fluff.