Six Myths About Venture Capitalists

by Diane Mulcahy 

Steve Jobs, Mark Zuckerberg, Sergey Brin: We celebrate these entrepreneurs for their successes, and often equally extol the venture capitalists who backed their start-ups and share in their glory. Well-known VC firms such as Kleiner Perkins and Sequoia have cultivated a branded mystique around their ability to find and finance the most successful young companies. Forbes identifies the top individual VCs on its Midas List, implicitly crediting them with a mythical magic touch for investing. The story of venture capital appears to be a compelling narrative of bold investments and excess returns.

The reality looks very different. Behind the anecdotes about Apple, Facebook, and Google are numbers showing that many more venture-backed start-ups fail than succeed. And VCs themselves aren’t much better at generating returns. For more than a decade the stock markets have outperformed most of them, and since 1999 VC funds on average have barely broken even.

The VC industry wouldn’t exist without entrepreneurs, yet entrepreneurs often feel as if they’re in the backseat when it comes to dealing with VCs. For someone who’s starting (or thinking of starting) a company, the myths surrounding venture capital can be powerful. In this article I will challenge some common ones in order to help company founders develop a more realistic sense of the industry and what it offers.

Myth 1: Venture Capital Is the Primary Source of Start-Up Funding
Venture capital financing is the exception, not the norm, among start-ups. Historically, only a tiny percentage (fewer than 1%) of U.S. companies have raised capital from VCs. And the industry is contracting: After peaking in the late 1990s, the number of active VC firms fell from 744 to 526 in the decade 2001–2011, and the amount of venture capital raised was just under $19 billion in 2011, down from $39 billion in 2001, according to the National Venture Capital Association (NVCA).

But less venture capital doesn’t mean less start-up capital. Non-VC sources of financing are growing rapidly and giving entrepreneurs many more choices than in the past. Angel investors—affluent individuals who invest smaller amounts of capital at an earlier stage than VCs do—fund more than 16 times as many companies as VCs do, and their share is growing. In 2011 angels invested more than $22 billion in approximately 65,000 companies, whereas venture capitalists invested about $28 billion in about 3,700 companies. AngelList, an online platform that connects start-ups with angel capital, is one example of the enormous growth in angel financing. Since it launched, in 2010, more than 2,000 companies have raised capital using the platform, and start-ups now raise more than $10 million a month there. (Disclosure: The Kauffman Foundation is an investor in AngelList.)

Another new source of start-up investment is crowdfunding, whereby entrepreneurs raise small amounts of capital from large numbers of people in exchange for nonequity rewards such as products from the newly funded company. Kickstarter reports that more than 18,000 projects raised nearly $320 million through its platform in 2012—triple the amount raised in 2011. Passage of the JOBS (Jumpstart Our Business Startups) Act last year promises to support even faster growth by allowing crowdfunders to invest in exchange for equity and by expanding the pool of investors who can participate. 

Myth 2: VCs Take a Big Risk When They Invest in Your Start-Up
VCs are often portrayed as risk takers who back bold new ideas. True, they take a lot of risk with their investors’ capital—but very little with their own. In most VC funds the partners’ own money accounts for just 1% of the total. The industry’s revenue model, long investment cycle, and lack of visible performance data make VCs less accountable for their performance than most other professional investors. If a VC firm invests in your start-up, it will be rooting for you to succeed. But it will probably do just fine financially even if you fail.

Why? Because the standard VC fund charges an annual fee of 2% on committed capital over the life of the fund—usually 10 years—plus a percentage of the profits when firms successfully exit, usually by being acquired or going public. So a firm that raised a $1 billion fund and charged a 2% fee would receive a fixed fee stream of $20 million a year to cover expenses and compensation. VC firms raise new funds about every three or four years, so let’s say that three years into the first fund, the firm raised a second $1 billion fund. That would generate an additional $20 million in fees, for a total of $40 million annually. These cumulative and guaranteed management fees insulate VC partners from poor returns because much of their compensation comes from fees. Many partners take home compensation in the seven figures regardless of the fund’s investment performance. Most entrepreneurs have no such safety net.

Other investment professionals often face far greater performance pressure. Consider mutual fund managers, whose fund performance is reported daily, whose investors can withdraw money at any time, and who are often replaced for under performance. VC performance is ultimately judged at the end of a fund’s 10-year life, so venture capitalists are free from the level of accountability that’s common in other investment realms. They take on less personal risk than angel investors or crowdfunders, who use their own capital. And all investors take fewer risks than most entrepreneurs, who put much of their net worth and all of their earning capacity into their start-ups. 

Myth 3: Most VCs Offer Great Advice and Mentoring

A common VC pitch to entrepreneurs is that the firm brings much more than money to the table: It offers experience, operational and industry expertise, a broad network of relevant contacts, a range of services for start-ups, and a strong track record of successful investing.

In some cases those nonmonetary resources really are valuable. But VCs vary tremendously—both as firms and as individuals—in how much effort they put into advising and assisting portfolio companies. Among those who do mentor their CEOs, ability and the quality of advice can differ widely. There are no solid data about the industry’s delivery on this mentoring promise. But if you asked the CEOs of 100 VC-funded companies how helpful their VCs are, some would say they’re fabulous, some would say they’re active but not a huge help, and some would say they do little beyond writing checks. This last group isn’t necessarily bad, of course: Some CEOs may be happy to skip the mentoring and just take the cash. But for founders who have bought into the idea that VCs provide lots of value-added help, it can be a source of great disappointment.

The best way to determine whether a VC firm or partner brings resources other than capital to the table is to conduct your own due diligence, just as you’d do a thorough reference check on a key hire. Talk with the CEOs of the firm’s other portfolio companies and ask if the partner is accessible, how much he or she adds to boardroom discussion, and whether the CEO has received constructive help in dealing with company problems. Ask about resources the firm offers—PR, recruiting, and so forth—and whether those have been useful.

Some questions you should ask the VC firm directly, such as: Whom does it intend to put on your board? Is the person a partner or an associate? Does the person have any experience (or any other portfolio companies) in your industry? On how many other boards does he or she serve? Asking such questions may seem like common sense, but it’s shocking how few company founders actually make the necessary calls before signing up for a long-term relationship with a VC. If part of what makes a firm attractive is that it offers expertise, mentoring, and services, the entrepreneur needs to confirm that both the firm and the partner have a track record of delivering them. 

Myth 4: VCs Generate Spectacular Returns
Last year my colleagues at the Kauffman Foundation and I published a widely read report, “We Have Met the Enemy...and He Is Us,” about the venture capital industry and its returns. We found that the overall performance of the industry is poor. VC funds haven’t significantly outperformed the public markets since the late 1990s, and since 1997 less cash has been returned to VC investors than they have invested. A tiny group of top-performing firms do generate great “venture rates of return”: at least twice the capital invested, net of fees. We don’t know definitively which firms are in that group, because performance data are not generally available and are not consistently reported. The average fund, however, breaks even or loses money.

We analyzed the Kauffman Foundation’s experience investing in nearly 100 VC funds over 20 years. We found that only 20 of our funds outperformed the markets by the 3% to 5% annually that we expect to compensate us for the fees and illiquidity we incur by investing in private rather than public equity. Even worse, 62 of our 100 funds failed to beat the returns available from a small-cap public index.

Venture capital investments are generally perceived as high-risk and high-reward. The data in our report reveal that although investors in VC take on high fees, illiquidity, and risk, they rarely reap the reward of high returns. Entrepreneurs who are distressed when VCs decline to fund their ventures need only review the performance data to see that VCs as a group have no Midas touch for investing.

Myth 5: In VC, Bigger Is Better

Venture capital in the United States began as a cottage industry, notable in the early years for investments in companies such as Intel, Microsoft, and Apple. In 1990, 100 VC firms were actively investing, with slightly less than $30 billion under management, according to the NVCA. During that era venture capital generated strong, above-market returns, and performance by any measure was good. What happened? During the peak of the internet boom, in 2000, the number of active firms grew to more than 1,000, and assets under management exceeded $220 billion. VC didn’t scale well. As in most asset classes, when the money flooded in, returns fell, and venture capital has not yet recovered. The number of firms and the amount of capital have declined since the boom, though they are both still far above the levels of the early and middle 1990s.

What’s true for the industry is also true for individual funds: Bigger isn’t better. Company founders often feel that signing a deal with a large VC firm lends cachet, just as MBA students may get special pleasure from being offered a job by a big, well-known employer. But industry and academic studies show that fund performance declines as fund size increases above $250 million. We found that the VC funds larger than $400 million in Kauffman’s portfolio generally failed to provide attractive returns: Just four out of 30 outperformed a publicly traded small-cap index fund. 

Myth 6: VCs Are Innovators
It’s ironic that VC firms position themselves as supporters, financers, and even instigators of innovation, yet the industry itself has been devoid of innovation for the past 20 years. Venture capital has seen plenty of changes over time—more funds, more money, bigger funds, declining returns—but funds are structured, capital is raised, and partners are paid just as they were two decades ago. Any innovation in financing start-ups, such as crowdfunding and platforms like AngelList and SecondMarket, has come from outside the VC industry. 

The story of venture capital is changing. Entrepreneurs have more choices for financing their companies, shifting the historical balance of power that has too long tilted too far toward VCs. Entrepreneurs will enjoy a different view as they move from the backseat into the driver’s seat in negotiating with VCs. An emerging group of “VC 2.0” firms are going back to raising small funds and focusing on generating great returns rather than large fees. And the industry’s persistent underperformance is finally causing institutional investors to think twice before investing in venture capital. As a result, VCs will continue to play a significant, but most likely smaller, role in channeling capital to disruptive start-ups.

Diane Mulcahy, a former venture capitalist, is the director of private equity for the Ewing Marion Kauffman Foundation, an adjunct lecturer in the entrepreneurship division at Babson College, and an Eisenhower Fellow.  

7 Elements of a Great Company Culture

Build these things into your culture and your rock star talent will take you to the top.

By Marla Tabaka

IMAGE: Getty Images

What does it really mean to build a strong culture? For some entrepreneurs the very word conjures up images of employees dancing on desks, playing pool in the break room, and napping away in comfy, soundproof enclosures. While fun may be one component of a thriving culture, there's so much more to it. 

Build a culture based on your own values, but don't forget these 7 musts.

1. If you want to be trusted, you must trust.

A culture of trust is imperative, especially if you're employing millennials. If you behave like a helicopter parent, overseeing, or worse, taking over every project, it will directly conflict with the building of trust. What if they make a mistake? I think any successful entrepreneur will tell you that there is no mistake from which you cannot recover. Give your employees clear guidelines and let them spread their wings.

2. Give employees the opportunity to get to know one another.

How can people know, like, and trust one another if they don't have the opportunity to play together? An occasional party or outing is not enough to build and maintain these relationships; weave these events into the fabric of your day-to-day company life. Create little rituals at employee meetings, have themes for certain days of the week and holidays, and engage in community projects together. Find quirky ways to celebrate success, no matter how small, and certainly create friendly competition; both work-related and personal. A chili cook-off and a game-filled afternoon at the park are a couple of things to consider. Too much work? Assign a monthly "culture captain" to plan out the month.

3. Create a cool space.

Tossing a few desks in a room doesn't cut it anymore. Our external environment has a significant impact on our internal thought process. Design a creative corner with bean bag chairs, chalk boards, and a lighthearted theme throughout. Allow employees to bring fun decorations to add to their work area. If you can afford it, hire a designer to create your unique space. A creative environment sets the bar for innovation. Creating a "culture of cool" attracts the kind of people who value the kind of culture you're trying to build.

4. Give 'em free stuff.

Everyone loves free stuff! If you can't afford to supply personal computers or tablets, stock options, and grand parties--no worries, those things will come. In the meantime Friday morning breakfasts, afternoon smoothies, fun work tools, and inexpensive merchandise will go a long way. This will contribute to a work-hard, play-hard environment, making for happy, productive, and creative employees.

5. No jerks allowed.

I can't say this often enough: Hiring for skill alone will doom you to misery. Hire nice people who fit in with the intention design of your culture. Hire people who have a proven work ethic and are team players. Hire for creativity and personality. Sure, experience and skill are important, but not nearly enough to take you to the top of your industry.

6. Encourage growth and ownership.

A strong company culture isn't just about fun: it's about encouraging your employees to see their job as more than just a job--to own their job and their ideas. Once you've build this collaborative, trusting environment, your employees will bring ideas to the table. If it's their idea, put them in charge of it! If an employee wants to learn something new, provide the support for them to do it. Today, innovative companies don't hire employees to remain in one job for an eternity; they hire innovators who will contribute to the future of the company in a powerful way.

7. Communicate, communicate, communicate.

Here's where I see entrepreneurs, especially startups, fail most often. When one hand doesn't know what the other is doing you have a recipe for disaster. But communication about processes and workflow aren't enough. Drill your values into your employees with ideas like those above and by demonstrating them in your own behavior. Be authentic and, at times, vulnerable. If an employee isn't performing up to par, don't let your frustration and disappointment grow; engage in thoughtful conversations about it and create a plan for improvement. If an employee has a win, celebrate! 

Building an outstanding culture is not an overnight event, and it's not always easy. You'll hit some bumps in the road. Never forget that your team, not your product, not your bank account, is your number-one asset.

Why Tinkering Around is the Key to Success

Bruce Kasanoff

 

Here is a quick way to judge whether your company will continue to be successful: can you tell your CEO that you spent the morning tinkering around with an idea? If the answer is yes, you are in good shape. If no, start looking for another job.

Successful companies know that the path to innovation isn't a straight line. Profitable growth is a messy, roller-coaster process that involves almost as many setbacks as victories. If you succeed in everything you do, you aren't aiming nearly high enough.

I get frustrated when companies talk and talk and talk about innovation, while simultaneously making it nearly impossible for their employees to tinker around. Tinkering is what drives innovation, not talking.

Tinkering lets you try different combinations, to stumble upon outcomes you never expected, and to experiment until you figure out how to get predictable results.

Last month, I tried to write a convincing article about the business value of tinkering around, and failed miserably. Not many people read my story, and the few who did missed my point. (This was my fault, not theirs.)

This was all a bit ironic, because my point was that most innovation is the result of persistent tinkering. So I tinkered with my approach, and today I am trying again. 

Big companies hate tinkering, and many small ones do, too
When companies get too big and too bureaucratic, they abhor the idea of tinkering around with a product, service or process. To them, it sounds amateurish. You can almost hear these lumbering giants saying: we are too professional to get on the floor like kids and keep taking stuff apart and putting it back together in a slightly different combination.

The same can be true for small, slowly growing businesses. You know the ones I mean, those that had 12 employees in 2003, and still have 12 employees. They do things the same way year after year, and almost never tinker around with the way their business operates.

I've resisted the impulse to talk about famous innovators in this piece, because that would imply that tinkering around is only for inventors seeking to get rich. To the contrary, tinkering around is for everyone. It's a way to improve your resume, refine a cover letter, learn a new 
language, and take five strokes off your golf game. 

Posted by:Bruce Kasanoff

The Innovation Mindset in Action: Sir Peter Jackson

by Vijay Govindarajan and Srikanth Srinivas 

Peter Jackson is a game changer who transformed the practice of filmmaking. Like Jerry Buss, who revolutionized basketball, Jackson and other effective innovators share a common set of qualities that we call the innovation mindset: they see and act on opportunities, use "and" thinking and resourcefulness, focus on outcomes, and act to "expand the pie." Regardless of where they start, innovators persist till they successfully change the game.

As an only child, Jackson was often left to entertain himself. His parents bought him an 8-mm movie camera when he was 8 years old. At 16, he left school to work as a full time photo-engraver, saving as much money as he could for film equipment. He began making short films with his friends. These were amateurish horror movies, but they won awards and had a cult following.

Jackson saw a unique opportunity in making hit movies with special effects that would keep people mesmerized in their seats. He got his first break with the Lord of the Rings (LOR) trilogy.

Jackson used "and thinking." He wanted the highest quality movies AND the lowest cost, so he made all three films in the LOR trilogy simultaneously. Hollywood's regular practice is to shoot movies in a trilogy one at a time, minimizing financial risk in case the first one flops. Lessons learned from the first movie can then be applied to the next, and cash flows from early films can be used to fund subsequent ones. Jackson, however, thought that shooting the trilogy in one go would decrease costs and improve quality. If all three films were shot simultaneously, sets would need to be built only once, rather than built up and brought down three times. Shooting the trilogy simultaneously would avoid the costs of actors' potential salary increases over time, especially if the first film proved a hit, and would also prevent characters from aging (or even dying) between one film and the next. New Line Cinema knew this was a gamble but had faith in Peter Jackson's vision and capabilities, trusting that the series would appear seamless if the three films were shot at once.

Jackson managed what may have been risks in others' eyes by being resourceful and focusing on outcomes.

By being resourceful, Jackson managed to keep costs down to $280 million for all three movies. He insisted on shooting the movie and doing all the animation in New Zealand so he could manage both the quality and the cost, despite Hollywood pressure to use animation studios like Pixar. The result was Weta Workshop—a group of organizations, co-founded by Jackson, and dedicated to special effects for movie and television. Jackson also introduced innovative ways to increase LOR viewership. For example, he made a free video for Air New Zealand to make the "seat belt and related" announcements—using LOR characters. Many who saw it got curious and went to see the movies.

His outcomes and accomplishments were extraordinary: The LOR trilogy made for $280 million grossed $6 billion and won 17 Oscars. Weta has grown to be a well-known animation and special effects company with a special twist on horror, employing thousands of people. With Weta, Jackson achieved his vision of dramatically increasing the amount of work done digitally, without affecting quality. As a result, Weta can digitally create environments, characters, creatures, costumes, weapons, props, and vehicles with animation and real life 3D effects.

In honor of his significant accomplishments and contributions to his country, Jackson was made a Knight Companion of the New Zealand Order of Merit in 2010.

Jackson expanded the pie and completely transformed the movie industry in New Zealand, so much so that Wellington has become Wellywood and filmmakers like James Cameron have purchased New Zealand property. Jackson also expanded the pie by extending LOR's success to others' projects. Ian Brodie, an extra in the films, wanted to write a book about the locations where LOR was shot. Jackson shared all the location details with Brodie and the resulting book, The Lord of the Rings Locations Guidebook, was a runaway bestseller. Jackson allowed Jens Hansen, the local jeweler who made the ring for the movie, to reproduce it. The book and the jewelry expand the audience for the movie, and vice versa.

Sir Peter Jackson is a game changer. He has transformed much more than the movie industry in New Zealand—he has also transformed filmmaking globally. 

Vijay Govindarajan and Srikanth Srinivas

Vijay Govindarajan is the Earl C. Daum 1924 Professor of International Business at the Tuck School of Business at Dartmouth. He is coauthor of Reverse Innovation (HBR Press, 2012). Srikanth Srinivas is an innovation catalyst and the author of Shocking Velocity.

Avoid the Deadly Temptations that Derail Innovators

by Rosabeth Moss Kanter 

Any promising new initiative — a stand-alone business venture or an innovation in an established organization — hits roadblocks and unexpected obstacles. Recently I've advised entrepreneurs and innovators about a different, seemingly better, dilemma: pop-up opportunities that look like short cuts to success. Too often, these turn out to be deadly temptations.

Consider these cases (with names disguised to protect confidentiality):

Bill's venture capital-backed business concept was to operate a new revenue-producing service for large U.S. professional organizations. In its first year, the venture landed two almost-committed pilot sites and a prospect pipeline for a multi-billion-dollar market. But almost at the same time, Bill was offered a lucrative deal to build a similar service for an English-speaking country outside the U.S. Feeling that the money was good and the chance to show credibility to U.S. customers even better, Bill took the deal, brushing aside numerous challenging differences and departures from his model. Then he was offered an even bigger international site in a developing country eager for American know-how, in partnership with a U.S. organization that could also be a customer. His financial backers urged him to take it — it would mean more revenue, fast. Suddenly Bill was in a different, less appealing business, jeopardizing building the U.S. business.

In this story, that giant sucking sound you hear is the draining of time and energy from the core business by tempting almost-related opportunities. The danger comes from possibilities that are close enough to be plausible but take attention away from the building the main business and don't prove the concept anyway. 

Mary's temptations were slightly different but had similar consequences. She started a non-profit organization with lavish foundation funding and a high-profile board in order to spread an innovation in health care. This was a situation devoutly to be wished for by most social causes, but it proved limiting and almost fatal to Mary's project. The staff proliferated without clarity of purpose, and the organization became insular, looking inward and feeling they must be at the top of their field. Other groups courted the organization because it could bring funding, not because of a commitment to the innovation. Soon the goal became how to raise money, not how to support and improve the innovation. The organization took some government contracts to provide a somewhat-related but more routine service. Donors became confused about what the organization did. Private funding declined. The venture was in peril.

Ironically, these problems come along with looking like you might succeed. Investors, donors, potential partners, or bosses shower temptations on entrepreneurs who show promise. Joe's first wildly successful conference, accompanied by highly creative marketing, drew offers to him from investors who wanted to back him to go national, people who wanted to hire him to popularize their work, and companies that wanted him to be a distributor for merchandise sales. Joe was dazzled by the big-name people interested in him. But none of this built Joe's brand. The graveyard of startups is filled with innovators lured by glamour to let others take over their concept before it was fully developed.

In the western classic The Odyssey, Odysseus put wax in his sailors' ears and tied himself to his boat to avoid being tempted by the sirens and lured into lethal rocks. In her new book Sidetracked, my HBS colleague Francesa Gino outlines ways to handle more contemporary distractions. Entrepreneurs who want to avoid the deadly temptations I identify here can take these actions:

Establish principles by which opportunities will be judged. Creating new initiatives benefits from the flexibility to improvise, as I've written, but boundaries and direction ensure that efforts add up in a coherent way and can be replicated and scaled. Strategy is what you don't do, not just what you do, as my HBS colleague Michael Porter has said.

Prove the concept you want to prove. Most people are concrete thinkers who will assume that a project is whatever they first see — why Bill's strategy for a prototype was very risky. It's important to build into the first model at least one glimmer of everything you anticipate for the full product, while screening out anything that doesn't signal future aspirations. For example, if you want corporate partners eventually, get at least one before you start. If you want to reach full potential in the domestic market, hold off on international forays. Sometimes walking away from money is smart strategy if it comes with unrelated requirements.

Control your identity. Put the right words around the project, and stick with them. Observers often reduce innovations to familiar elements, using language they already have, but which might not fit the initiative, leading to offers of distracting opportunities when the core business isn't understood. One innovation group developed a glossary of terms to be used, and words to be avoided. The same group also declined an investment from a source that would have sent misleading signals about the business the venture was in. 

Don't lean insular. Innovators can lean in so far that they become insular. talking only to those that agree with them or flatter them. Was Kodak's demise precipitated by being Rochester-centric, where they were top of the heap, rather than mingling more in Silicon Valley where people had different views of the future of photography? Bill, Mary, and Joe were so flattered by money that they didn't check with outside experts who would have warned them of the dangers ahead.

In short, to get to where you want to go, ignore the deadly temptations that might spring up on an innovation journey. Stay focused on the purpose and the destination.

Rosabeth Moss Kanter

Rosabeth Moss Kanter is a professor at Harvard Business School and the
author of Confidence and SuperCorp. Her 2011 HBR article, "How Great Companies Think Differently," won a McKinsey Award for best article. Connect with her
on Facebook or at Twitter.com/RosabethKanter.

Experimental Innovators Peak In Creativity Late In Life

University of Chicago economist David Galenson's research has found that experimental innovators peak in creativity late in life, when the accumulated experience and time spent honing their craft coalesces into brilliance. Just look at the careers of Virginia Woolf, Paul Cézanne, Fyodor Dostoevsky, or John Darwin, all of whom made tremendous contributions after a long career. "These are people who work by trial and error, work uncertainly, and they become great later rather than early," he says.

Why Innovators Get Better With Age

By TOM AGAN

“WE need some gray hair” once referred to needing someone with more experience. But I haven’t heard that expression in a very long time.

In fact, many companies are intentionally reducing the average age of their work forces in an effort to save money. Younger employees are generally paid less and have lower health care expenses and retirement costs. As one executive remarked to me recently, “I don’t think anyone really likes this — we all know our own 50-year-old moment will be coming, too.” 

There is a surprising downside, however, to encouraging older workers to leave or, at some companies, pushing them out: Less gray hair sharply reduces an organization’s innovation potential, which over the long term can greatly outweigh short-term gains. 

The most common image of an innovator is that of a kid developing a great idea in a garage, a dorm room or a makeshift office. This is the story of Mark Zuckerberg of Facebook, Bill Gates of Microsoft, and Steve Jobs and Steve Wozniak of Apple. Last week, Yahoo announced that it had bought a news-reading app developed by Nick D’Aloisio, who is all of 17. 

In reality, though, these examples are the exception and not the rule. Consider this: The directors of the five top-grossing films of 2012 are all in their 40s or 50s. And two of the biggest-selling authors of fiction for 2012 — Suzanne Collins and E. L. James — are around 50. 

According to research, the age of eventual Nobel Prize winners when making a discovery, and of inventors when making a significant breakthrough, averaged around 38 in 2000, an increase of about six years since 1900. 

But there is another reason to keep innovators around longer: the time it takes between the birth of an idea and when its implications are broadly understood and acted upon. This education process is typically driven by the innovators themselves. 

For Nobel Prize winners, this process usually takes about 20 years — meaning that someone who is 38 at the time of discovery will most likely be nearly 60 when he or she receives the prize. For most eventual laureates, that interval is spent attending and making presentations at conferences, networking with colleagues, writing additional papers, editing academic journals and talking with the press. 

Let’s assume that with company resources, it will take a corporate innovator 10 years instead of 20 to educate others about the nature, implications and applications of a new idea. If that’s true, a reasonable target retention age for attaining an average level of innovation would be at least 50. 

YET despite the overall aging of the work force, many organizations are heading in the opposite direction. One executive at a major investment bank remarked with concern that the average age at his firm was 32. This phenomenon is not unique to corporations. Many medical institutions and universities  have also shifted to younger workforces. But according to research by Benjamin Jones of Northwestern University, a 55-year-old and even a 65-year-old have significantly more innovation potential than a 25-year-old. 

If an organization wants innovation to flourish, the conversation needs to change from severance packages to retention bonuses. Instead of managing the average age downward, companies should be managing it upward. 

We can act within our own organizations to make a difference. For example, we can end policies that limit the time people are allowed to stay at a certain level in a given position. And we can stop rotating high-potential managers across different businesses. Instead, we need to encourage the best performers to stay put, giving them the years — perhaps even decades — to support and lead major innovations from inception to commercial launch. 

And to encourage innovation, we must provide economic incentives to C.E.O.’s, boards of directors and investors through changes in the tax code and elsewhere that favor long-term returns driven by innovation over shortsighted pressure to reduce costs.

The journalist A. J. Jacobs has perfectly described our current situation when it comes to the relationship between age and innovation. In his book “The Year of Living Biblically,” he writes: “I’m 38, which means I’m a few years from my first angioplasty, but — at least in the media business — I’m considered a doddering old man. I just hope the 26-year-old editors out there have mercy on me.” 

Relax, A. J., you still have a few more years to hit it out of the ballpark with a mega-best seller.

Tom Agan, 51, is a co-founder and the managing partner of Rivia, an innovation and brand consulting firm.

Six Myths About Venture Capitalists

by Diane Mulcahy

 

Steve Jobs, Mark Zuckerberg, Sergey Brin: We celebrate these entrepreneurs for their successes, and often equally extol the venture capitalists who backed their start-ups and share in their glory. Well-known VC firms such as Kleiner Perkins and Sequoia have cultivated a branded mystique around their ability to find and finance the most successful young companies. Forbes identifies the top individual VCs on its Midas List, implicitly crediting them with a mythical magic touch for investing. The story of venture capital appears to be a compelling narrative of bold investments and excess returns.

The reality looks very different. Behind the anecdotes about Apple, Facebook, and Google are numbers showing that many more venture-backed start-ups fail than succeed. And VCs themselves aren’t much better at generating returns. For more than a decade the stock markets have outperformed most of them, and since 1999 VC funds on average have barely broken even.

The VC industry wouldn’t exist without entrepreneurs, yet entrepreneurs often feel as if they’re in the backseat when it comes to dealing with VCs. For someone who’s starting (or thinking of starting) a company, the myths surrounding venture capital can be powerful. In this article I will challenge some common ones in order to help company founders develop a more realistic sense of the industry and what it offers.

 

Myth 1: Venture Capital Is the Primary Source of Start-Up Funding
Venture capital financing is the exception, not the norm, among start-ups. Historically, only a tiny percentage (fewer than 1%) of U.S. companies have raised capital from VCs. And the industry is contracting: After peaking in the late 1990s, the number of active VC firms fell from 744 to 526 in the decade 2001–2011, and the amount of venture capital raised was just under $19 billion in 2011, down from $39 billion in 2001, according to the National Venture Capital Association (NVCA).

But less venture capital doesn’t mean less start-up capital. Non-VC sources of financing are growing rapidly and giving entrepreneurs many more choices than in the past. Angel investors—affluent individuals who invest smaller amounts of capital at an earlier stage than VCs do—fund more than 16 times as many companies as VCs do, and their share is growing. In 2011 angels invested more than $22 billion in approximately 65,000 companies, whereas venture capitalists invested about $28 billion in about 3,700 companies. AngelList, an online platform that connects start-ups with angel capital, is one example of the enormous growth in angel financing. Since it launched, in 2010, more than 2,000 companies have raised capital using the platform, and start-ups now raise more than $10 million a month there. (Disclosure: The Kauffman Foundation is an investor in AngelList.)

Another new source of start-up investment is crowdfunding, whereby entrepreneurs raise small amounts of capital from large numbers of people in exchange for nonequity rewards such as products from the newly funded company. Kickstarter reports that more than 18,000 projects raised nearly $320 million through its platform in 2012—triple the amount raised in 2011. Passage of the JOBS (Jumpstart Our Business Startups) Act last year promises to support even faster growth by allowing crowdfunders to invest in exchange for equity and by expanding the pool of investors who can participate.

 

Myth 2: VCs Take a Big Risk When They Invest in Your Start-Up
VCs are often portrayed as risk takers who back bold new ideas. True, they take a lot of risk with their investors’ capital—but very little with their own. In most VC funds the partners’ own money accounts for just 1% of the total. The industry’s revenue model, long investment cycle, and lack of visible performance data make VCs less accountable for their performance than most other professional investors. If a VC firm invests in your start-up, it will be rooting for you to succeed. But it will probably do just fine financially even if you fail.

Why? Because the standard VC fund charges an annual fee of 2% on committed capital over the life of the fund—usually 10 years—plus a percentage of the profits when firms successfully exit, usually by being acquired or going public. So a firm that raised a $1 billion fund and charged a 2% fee would receive a fixed fee stream of $20 million a year to cover expenses and compensation. VC firms raise new funds about every three or four years, so let’s say that three years into the first fund, the firm raised a second $1 billion fund. That would generate an additional $20 million in fees, for a total of $40 million annually. These cumulative and guaranteed management fees insulate VC partners from poor returns because much of their compensation comes from fees. Many partners take home compensation in the seven figures regardless of the fund’s investment performance. Most entrepreneurs have no such safety net.

Other investment professionals often face far greater performance pressure. Consider mutual fund managers, whose fund performance is reported daily, whose investors can withdraw money at any time, and who are often replaced for under performance. VC performance is ultimately judged at the end of a fund’s 10-year life, so venture capitalists are free from the level of accountability that’s common in other investment realms. They take on less personal risk than angel investors or crowdfunders, who use their own capital. And all investors take fewer risks than most entrepreneurs, who put much of their net worth and all of their earning capacity into their start-ups.

 

Myth 3: Most VCs Offer Great Advice and Mentoring

A common VC pitch to entrepreneurs is that the firm brings much more than money to the table: It offers experience, operational and industry expertise, a broad network of relevant contacts, a range of services for start-ups, and a strong track record of successful investing.

In some cases those nonmonetary resources really are valuable. But VCs vary tremendously—both as firms and as individuals—in how much effort they put into advising and assisting portfolio companies. Among those who do mentor their CEOs, ability and the quality of advice can differ widely. There are no solid data about the industry’s delivery on this mentoring promise. But if you asked the CEOs of 100 VC-funded companies how helpful their VCs are, some would say they’re fabulous, some would say they’re active but not a huge help, and some would say they do little beyond writing checks. This last group isn’t necessarily bad, of course: Some CEOs may be happy to skip the mentoring and just take the cash. But for founders who have bought into the idea that VCs provide lots of value-added help, it can be a source of great disappointment.

The best way to determine whether a VC firm or partner brings resources other than capital to the table is to conduct your own due diligence, just as you’d do a thorough reference check on a key hire. Talk with the CEOs of the firm’s other portfolio companies and ask if the partner is accessible, how much he or she adds to boardroom discussion, and whether the CEO has received constructive help in dealing with company problems. Ask about resources the firm offers—PR, recruiting, and so forth—and whether those have been useful.

Some questions you should ask the VC firm directly, such as: Whom does it intend to put on your board? Is the person a partner or an associate? Does the person have any experience (or any other portfolio companies) in your industry? On how many other boards does he or she serve? Asking such questions may seem like common sense, but it’s shocking how few company founders actually make the necessary calls before signing up for a long-term relationship with a VC. If part of what makes a firm attractive is that it offers expertise, mentoring, and services, the entrepreneur needs to confirm that both the firm and the partner have a track record of delivering them.

 

Myth 4: VCs Generate Spectacular Returns
Last year my colleagues at the Kauffman Foundation and I published a widely read report, “We Have Met the Enemy...and He Is Us,” about the venture capital industry and its returns. We found that the overall performance of the industry is poor. VC funds haven’t significantly outperformed the public markets since the late 1990s, and since 1997 less cash has been returned to VC investors than they have invested. A tiny group of top-performing firms do generate great “venture rates of return”: at least twice the capital invested, net of fees. We don’t know definitively which firms are in that group, because performance data are not generally available and are not consistently reported. The average fund, however, breaks even or loses money.

We analyzed the Kauffman Foundation’s experience investing in nearly 100 VC funds over 20 years. We found that only 20 of our funds outperformed the markets by the 3% to 5% annually that we expect to compensate us for the fees and illiquidity we incur by investing in private rather than public equity. Even worse, 62 of our 100 funds failed to beat the returns available from a small-cap public index.

Venture capital investments are generally perceived as high-risk and high-reward. The data in our report reveal that although investors in VC take on high fees, illiquidity, and risk, they rarely reap the reward of high returns. Entrepreneurs who are distressed when VCs decline to fund their ventures need only review the performance data to see that VCs as a group have no Midas touch for investing.

Myth 5: In VC, Bigger Is Better

Venture capital in the United States began as a cottage industry, notable in the early years for investments in companies such as Intel, Microsoft, and Apple. In 1990, 100 VC firms were actively investing, with slightly less than $30 billion under management, according to the NVCA. During that era venture capital generated strong, above-market returns, and performance by any measure was good. What happened? During the peak of the internet boom, in 2000, the number of active firms grew to more than 1,000, and assets under management exceeded $220 billion. VC didn’t scale well. As in most asset classes, when the money flooded in, returns fell, and venture capital has not yet recovered. The number of firms and the amount of capital have declined since the boom, though they are both still far above the levels of the early and middle 1990s.

What’s true for the industry is also true for individual funds: Bigger isn’t better. Company founders often feel that signing a deal with a large VC firm lends cachet, just as MBA students may get special pleasure from being offered a job by a big, well-known employer. But industry and academic studies show that fund performance declines as fund size increases above $250 million. We found that the VC funds larger than $400 million in Kauffman’s portfolio generally failed to provide attractive returns: Just four out of 30 outperformed a publicly traded small-cap index fund.

 

Myth 6: VCs Are Innovators
It’s ironic that VC firms position themselves as supporters, financers, and even instigators of innovation, yet the industry itself has been devoid of innovation for the past 20 years. Venture capital has seen plenty of changes over time—more funds, more money, bigger funds, declining returns—but funds are structured, capital is raised, and partners are paid just as they were two decades ago. Any innovation in financing start-ups, such as crowdfunding and platforms like AngelList and SecondMarket, has come from outside the VC industry. 

The story of venture capital is changing. Entrepreneurs have more choices for financing their companies, shifting the historical balance of power that has too long tilted too far toward VCs. Entrepreneurs will enjoy a different view as they move from the backseat into the driver’s seat in negotiating with VCs. An emerging group of “VC 2.0” firms are going back to raising small funds and focusing on generating great returns rather than large fees. And the industry’s persistent underperformance is finally causing institutional investors to think twice before investing in venture capital. As a result, VCs will continue to play a significant, but most likely smaller, role in channeling capital to disruptive start-ups.

Diane Mulcahy, a former venture capitalist, is the director of private equity for the Ewing Marion Kauffman Foundation, an adjunct lecturer in the entrepreneurship division at Babson College, and an Eisenhower Fellow.  

Why Innovators Get Better With Age

By TOM AGAN

“WE need some gray hair” once referred to needing someone with more experience. But I haven’t heard that expression in a very long time.

In fact, many companies are intentionally reducing the average age of their work forces in an effort to save money. Younger employees are generally paid less and have lower health care expenses and retirement costs. As one executive remarked to me recently, “I don’t think anyone really likes this — we all know our own 50-year-old moment will be coming, too.” 

There is a surprising downside, however, to encouraging older workers to leave or, at some companies, pushing them out: Less gray hair sharply reduces an organization’s innovation potential, which over the long term can greatly outweigh short-term gains. 

The most common image of an innovator is that of a kid developing a great idea in a garage, a dorm room or a makeshift office. This is the story of Mark Zuckerberg of Facebook, Bill Gates of Microsoft, and Steve Jobs and Steve Wozniak of Apple. Last week, Yahoo announced that it had bought a news-reading app developed by Nick D’Aloisio, who is all of 17. 

In reality, though, these examples are the exception and not the rule. Consider this: The directors of the five top-grossing films of 2012 are all in their 40s or 50s. And two of the biggest-selling authors of fiction for 2012 — Suzanne Collins and E. L. James — are around 50. 

According to research, the age of eventual Nobel Prize winners when making a discovery, and of inventors when making a significant breakthrough, averaged around 38 in 2000, an increase of about six years since 1900. 

But there is another reason to keep innovators around longer: the time it takes between the birth of an idea and when its implications are broadly understood and acted upon. This education process is typically driven by the innovators themselves. 

For Nobel Prize winners, this process usually takes about 20 years — meaning that someone who is 38 at the time of discovery will most likely be nearly 60 when he or she receives the prize. For most eventual laureates, that interval is spent attending and making presentations at conferences, networking with colleagues, writing additional papers, editing academic journals and talking with the press. 

Let’s assume that with company resources, it will take a corporate innovator 10 years instead of 20 to educate others about the nature, implications and applications of a new idea. If that’s true, a reasonable target retention age for attaining an average level of innovation would be at least 50. 

YET despite the overall aging of the work force, many organizations are heading in the opposite direction. One executive at a major investment bank remarked with concern that the average age at his firm was 32. This phenomenon is not unique to corporations. Many medical institutions and universities  have also shifted to younger workforces. But according to research by Benjamin Jones of Northwestern University, a 55-year-old and even a 65-year-old have significantly more innovation potential than a 25-year-old. 

If an organization wants innovation to flourish, the conversation needs to change from severance packages to retention bonuses. Instead of managing the average age downward, companies should be managing it upward. 

We can act within our own organizations to make a difference. For example, we can end policies that limit the time people are allowed to stay at a certain level in a given position. And we can stop rotating high-potential managers across different businesses. Instead, we need to encourage the best performers to stay put, giving them the years — perhaps even decades — to support and lead major innovations from inception to commercial launch. 

And to encourage innovation, we must provide economic incentives to C.E.O.’s, boards of directors and investors through changes in the tax code and elsewhere that favor long-term returns driven by innovation over shortsighted pressure to reduce costs.

The journalist A. J. Jacobs has perfectly described our current situation when it comes to the relationship between age and innovation. In his book “The Year of Living Biblically,” he writes: “I’m 38, which means I’m a few years from my first angioplasty, but — at least in the media business — I’m considered a doddering old man. I just hope the 26-year-old editors out there have mercy on me.” 

Relax, A. J., you still have a few more years to hit it out of the ballpark with a mega-best seller.

Tom Agan, 51, is a co-founder and the managing partner of Rivia, an innovation and brand consulting firm.