Melinda French Gates has set her sights on a formidable task – reshaping early-stage venture capital (VC) to better serve women entrepreneurs. Given that VCs cater to a select few, fail on about 80%, and need home runs to pay for the failures, the question looms: can Gates make a dent and leave a legacy? Or will she join a long line of well-meaning VC benefactors with loads of good intentions but without a foundational understanding of VC outside the narrow confines of Harvard, Stanford, and Silicon Valley?
Here are 5 challenges and potential solutions.
#1. The economics of VC… Need home runs.
VC is high-risk financing with success dependent on a few unicorns. A “typical” VC fund has about 20 percent write-offs, 40% failures that lose some money, and 20% break-even which do not offer a return to the VC (Designing Successful VC Funds for Economic Development, Dileep Rao, Applied Research in Economic Development, 2006 Volume 3, Number 2). This means that 20% of VC-funded ventures need to earn all the return. Gates’ success hinges on nurturing unicorn-entrepreneurs who not only fail less but also experience substantial growth. Without these “home runs,” the returns on VC investments remain meager. Gates must strategically develop and support ventures capable of achieving extraordinary success.
#2. Unraveling VC constraints… Shortage of home runs.
A stark reality about VC is that the Top 20 funds are said to earn about 95% of VC profits. This means that the remaining 98% of VC funds earn ~5% of VC profits. Another study shows that throughout the 2000s, the average and the median IRR for VC funds were negative for nearly every year. Gates faces the challenge of steering her constrained fund into the top tier to ensure reasonable returns. While her profit objectives may be lower than the Top 20 VCs, like any early-stage VC, she must secure some successes earning a high annual return and at least 1% of home runs in her fund to succeed. Given that most of the constraint-free VC funds struggle to earn a decent return, Gates’s constrained fund needs a better strategy to overcome the odds.
#3. The Gates fit… Avoiding the VC trap.
Gates’s commitment to invest in women-led funds and early-stage ventures and be a model for other investors means that she needs to avoid the common trap of philanthropic VCs who think that money alone will solve the problem. It will not as history has shown. She will have to develop unicorn-entrepreneurs to cut her losses and increase her successes.
#4. Developing unicorn-entrepreneurs… To avoid entrepreneur replacement.
VCs are selective and finance about 100/100,000 ventures because they want to find ventures with high potential, and then replace the entrepreneurs with a professional CEO on up to 85% of the ventures they fund. Even after being this picky, they fail on 80%. If Gates is going to help her selected segment of women entrepreneurs, without replacing them, she will need to train unicorn-entrepreneurs to bridge the gap from Idea to Aha! And then to scale up to unicorns after getting to Aha!
#5. Unleashing VC… Custom designing the women’s fund.
Gates can transform the landscape by custom designing her women-led ecosystem and by incorporating finance-smart strategies utilized by the 94% of billion-dollar entrepreneurs who took off without depending on VC. The strategies include embracing emerging trends, improving the product or service rather than seeking to be the first mover, finding and focusing on the dominant growth strategy, using smart capital and not VC, to takeoff and launch with control, and developing control, organization, and leadership skills
MY TAKE: VC has traditionally favored elite groups and universities. Can Gates broaden VC’s impact by training entrepreneurs, including women entrepreneurs, beyond traditional elite circles? Interestingly, the example of a Gates-financed venture given in the article is one started by a woman – from Harvard. To have a lasting impact, Gates needs to move beyond book-smart elites in privileged circles and champion street-smart unicorn-entrepreneurs everywhere.
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