Apr 8 2007 by Brad

Book Review: Venture Capital and the Finance of Innovation

I read a lot.  I often review books on my Feld Thoughts site but Venture Capital and the Finance of Innovation by Andrew Metrick seemed more appropriate for AsktheVC. 

If you are interested in how venture capital works, this is a superb book.  It’s broken into four parts – the first two are invaluable, the third is ok, and the fourth will only be interesting if you are working on your MBA and want to do some theoretical stuff that you’ll never use in the real world. 

Part 1 is titled VC Basics and covers the VC Industry, VC Players, VC Returns, The Cost of Venture Capital, The Best VCs, and VC around the world.  It’s a solid introduction to how the VC industry works.

Part 2 is titled Total Valuation.  This part has a bunch of juicy meat in it that is relevant to all entrepreneurs raising venture capital (as well as any new venture capitalist.)  It delves deep into the financial structuring of deals in sections titled The Analysis of VC Investments, Term Sheets, Preferred Stock, The VC Method, Discounted-Cash-Flow Analysis of Growth Companies, and Comparables Analysis.  The examples are extensive, build on themselves, and create a solid foundation for anyone that wants to understand the economics of venture capital.

Part 3 – titled Partial Valuation – is the section where it becomes apparent that Metrick is a professor at a business school.  While intellectually (and mathematically) interesting, most of this section is a departure from the practical reality of how most VCs think about deals.  While I’m sure the theory and examples will arm some eager new VCs with exciting justification for complex spreadsheet models to determine valuation, I’d suggest that there’s little practical value in this section.

Part 4 – titled The Finance of Innovation – is all business school stuff.  R&D Finance, Monte Carlo Simulation, Real Options, Binomal Trees, Game Theory, and R&D Valuation.  If you are an entrepreneur, give the following line a try at your next board meeting: “Mr. VC, can you share with me the binomial tree model that you used to come up with the current option price?”  That’ll get a laugh – at multiple levels.

Several of the appendicies are excellent, including Information Sources for Venture Capital and Sample Term Sheets.

Overall, Venture Capital and the Finance of Innovation is worth the price for simply the first two parts and the appendicies.  Unless you want to exercise your high school and college math skills, skim parts 3 and 4 and realize that most of the theory is just that.

If you are curious about other books we recommend on this site, take a look at the books tab for some of our other favorites.