Why do venture capitalists invest in money losing startups?

First you have to understand VCs are fund mangers who manage a fund. They need to return the fund in 8–10 years period and it has to make a profit for their investors.

When a VC raise fund from the investors, they must pitch a story where the ROI is better than other existing investments available for example properties. In 8–10 years period, properties can potentially bring 100% ROI. The VC fund needs to perform better than 100%, for say maybe 200% ROI.

There are only few ways for them to get their return back:

- Selling the shares out (in IPO or M&A)

- Dividen (your company is EXTREMELY profitable, applicable if the company already making huge profit)

Let’s see the assumptions below for selling shares in IPO or M&A:

Given that 90% of the early stage business will fail

If they raised $10M, investing $1M to 10 companies each, valuation at $5M each

Taking 20% equity that might be diluted down to 10% after few more rounds of funding

9 companies will be gone, the remaining 1 company has to be sold at $300M

VC gets $30M from their 10% equity to return 200% ROI

Therefore they need to find companies that can growth from a $5M to $300M valuation within 5–8 years. Hence, tech startups are their focus because tech startups can leverage on technology to scale and growth the business dramatically (j-curve / hockey stick) compared to other coventional businesses.