How Do Venture Capitalists Make Decisions?
On page 2, the paper has<p>&gt; In fact, Kaplan and Stromberg (2001) and Gompers and Lerner (2001) argue that
VCs are particularly successful at solving an important problem in market economies|connecting
entrepreneurs with good ideas (but no money) with investors who have money (but no ideas).<p>IMHO, for information technology (IT) venture capitalists (VCs), this statement about &quot;ideas&quot; is mostly wrong.  One reason the statement is wrong is that VCs will rarely even look in any detail at an <i>idea</i>.<p>In contrast the US NSF and DoD will look very carefully at ideas, e.g., GPS, stealth, measuring the 3 K background radiation.  So, will Ph.D. dissertation committees, reviewers at peer reviewed journals of original research, and more.  IT VCs won&#x27;t do such things.<p>IMHO what IT VCs look at is current <i>traction</i>, that is, users or revenue, and want that traction to be significant and growing rapidly.  Then if nothing else is wrong -- team, competition, scalability, etc. -- an IT VC can get very interested.<p>So, the VCs want the <i>idea</i> already implemented in hard&#x2F;software (usually software) and in the market and in front of users&#x2F;customers.<p>In the world of VCs, the <i>idea</i> is not something from research, that could be in a peer-reviewed papers, etc. but is just a short description of what the  business looks like externally to a casual observer, the <i>common man in the street</i>.  That there could be anything from a research <i>idea</i> as the crucial core of the business, crucial for getting the traction, being defensible and scalable, etc., is just ignored.<p>So, suppose some IT founding team has the coveted <i>traction</i>.  If they have lots of users, then the team should be able to run ads and get significant revenue.  If they have lots of customers, then they should also have significant revenue.<p>With that revenue, there will be some serious question if the team should accept equity funding, that is, accept the terms, a Delaware C-corporation, the BoD, reporting to the BoD that can fire team members, etc.  A C-corp and a BoD bring a lot of overhead.<p>Really, the example of the romantic match making service Plenty of Fish (PoF) starts to look more important as a example for IT startups in the future.  PoF was long just one guy, two old Dell servers, revenue just from ads and the ads just from Google, and $10 million a year in revenue.  As in<p><a href="http:&#x2F;&#x2F;techcrunch.com&#x2F;2015&#x2F;07&#x2F;14&#x2F;match-group-buys-plentyoffish-for-575m-to-bag-more-singles&#x2F;" rel="nofollow">http:&#x2F;&#x2F;techcrunch.com&#x2F;2015&#x2F;07&#x2F;14&#x2F;match-group-buys-plentyoffi...</a><p>on about July 14, 2015, the solo founder Markus Frind sold out for $575 million.<p>If a solo founder has a good <i>idea</i> that needs mostly only software, then there is a good chance they can just write the software, bring it to market, get <i>traction,</i> and have revenue enough for rapid <i>organic</i> (that is, funded by earnings from revenue) growth.<p>That is, a solo founder who invented the idea can keep costs, time on communications, etc. low, write the software, go to market, and get the traction.  That day is the first a VC wants to hear from that founder, and it is likely the last day the founder would be willing to accept a check, term sheet, etc. from a VC.<p>Net, with the VC rules, by the time the VC is willing to invest, the solo founder is beyond willing to accept the check.<p>Of course, if there are several founders, some high <i>burn rate</i>, maxed out credit cards, each of the founder with a pregnant wife, etc., then the VC&#x27;s check might be more welcome.<p>But we need to understand:  All across the US, entrepreneurs start and grow businesses -- pizza shops, auto body repair, dentist&#x27;s office, etc. -- without VC investing.  Then, the big difference for an IT startup is that some software and current computing, the Internet, etc. can let an entrepreneur make money much faster than a pizza shop.  E.g., suppose the founder&#x27;s business is a new Web site, and a lot of people like to connect.  Suppose the site sends 10 Web pages a second with each page with five ads.  Suppose get paid (from a report from Mary Meeker at VC firm KPCB) $2 per 1000 ads displayed.  Then the monthly revenue would be<p><pre><code>     10 * 5 * 2 * 3600 * 24 * 30 &#x2F; 1000 =   
     259,200
</code></pre>
dollars.  Heck, sending even just 1 page per second would yield $25,920 a month.  Then one founder with $25,920 a month in revenue growing rapidly is just the <i>traction</i> VCs want, but, with that <i>traction</i>, why should the founder want to accept the VC&#x27;s check?