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My name is Ilya Strebulaev,
and I'm a professor at the Stanford
Graduate School of Business,
as well as the Founder and Director
of our Venture Capital Initiative.
Unless you know where to look,
you might not see it,
but venture capitalists, or VCs,
are probably having a major impact
on your life every single day.
VCs are people who invest in small,
risky, high-growth startups, and
they often invest in companies that
are trying to change our world.
Think about Google,
Microsoft, Facebook, Zoom, many
other tech giants, they were all
funded by VCs back when there were
very companies.
My team and I tracked
the successful COVID vaccines, and
found that about half are delivered
by companies supported by venture
capital.
And even though it's in the news
a lot more during tech booms,
this powerful sector of the economy
predates the internet.
My research shows that since
the 1970s, the VC industry is
behind about a third of all large
publicly traded companies
created in the United States.
So, how do these influential
people choose what ideas to fund?
Even many company founders seeking
venture capital money don't really
seem to understand the VC mindset,
as I call it.
That's what my research set
out to domestify.
My team and I found that the most
important stage is what's referred
to as deal selection.
Deal selection is after they've
already identified a startup to
consider, but
before VCs decide whether
to investment or not to invest.
During the deal selection process,
VCs put every potential investment
through something they
call the deal funnel.
On average, a hundred startups go
into the deal funnel, and
only one comes out, meaning that
VCs invest in about one startup for
each hundred that they consider.
The first part of the funnel
is typically where VCs evaluate the
business model and the setup idea.
Often VCs will say, well,
the market is obviously too small,
so therefore,
we don't have any interest.
If the startup passes that stage,
then VCs will typically meet with
the founding team to evaluate them.
Again, often enough VCs will say,
well, the business is interesting,
but we're not impressed by
the founding team.
That's another startup squeezed out
of the narrowing funnel.
At the next stage, which relatively
few deals reach, they'll bring this
startup to their partners.
And then the partners will decide
to proceed with a very careful due
diligence on only some of
the deals.
On average, this entire process
takes almost three months, and
it's highly selective.
What we found was that the median
venture capital firm considers
about 400 deals a year, and
only invests in 4.
That highly selective process
benefits us all down the line.
For example, my research shows that
without venture capitalists,
companies like Zoom might not have
been identified, created,
funded, or scaled up.
And of course had Zoom not existed,
our experience during the COVID
pandemic would've
been quite different.
VCs' rigorous decision
making process can increase
the success rate of companies that
change our lives.
So how can a business idea make it
through the deal funnel?
My team and I talked to almost
900 venture capitalists at over
700 firms, asking these questions,
many of those for the first time.
We found that in order to try and
minimize risk, VCs tend to
concentrate on what I call
the jockey rather than the horse.
The jockey is the founders and the
early management team of a company,
in other words, the human element,
the human capital.
The horse is everything else,
the product, business model,
market, technology.
Most VCs will not invest unless
they have complete trust in that
early management team that they can
execute on the idea.
Even with the best course,
VCs figure out that without
a good jockey to ride it,
it'll not be winning the race.
Putting together those hundreds of
servers and conversations with
venture capitalists, we started
to get a clearer picture of who
they are and who they aren't.
It turns out that the VC mindset is
very different from other
financial investors.
They consider many more
opportunities to start with, other
investors will not have as wide a
deal funnel as venture capitalists.
Vcs are also much more ready
to take on risks, and they're much
more likely to co-invest with other
venture capitalists, so they're
a part of a larger ecosystem.
Because of all these differences,
VCs have to come up with their own
financial strategies.
Because the standard financial
models like the ones we teach our
MBA students here at Stanford
aren't really applicable that much
to early stage companies.
Concepts like net present value, or
discounted cash flow techniques,
just aren't that much in use,
since you can't predict future cash
flows have an idea or forecast
revenue without reliable data.
And the data for these startups
just doesn't exist yet.
So, if you are not investing
millions in startups,
how does this all relate to you?
Well, we can all probably benefit
from thinking a little bit more
like VCs.
For example, people tend to be
extremely risk-averse,
so are corporate decision-makers.
And when you invest, that actually
might not be a bad idea.
But when you're trying something
new, either your personal or
professional life,
being willing to fail and
staying flexible is beneficial.
That's what the VC mindset is
all about.
VCs have a lot to teach us about
doing plenty of research
before making decisions, but
also experimenting and
keeping an open mind.
That's how you win big in business.
And the same is true in life.
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