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I haven't looked too much into this space, but what about this rationale: the existing model pushes startups into 1000x-or-bust behavior, which contributes to t

I haven't looked too much into this space, but what about this rationale: the existing model pushes startups into 1000x-or-bust behavior, which contributes to the low success rate, which reinforces the need for high-risk growth followed by a spectacular cash-out. This could be driven by many factors, not least of which is the "brand name VC" model in which venture funds need a couple household name home runs to attract the best deals. Perhaps the "crowd" model would allow the creation of smaller, lower-growth companies that could dominate a niche or region, and generate long-term dividend returns for investors rather than immediate capital gains. It could fill the space between debt and growth equity for companies that have ambitions beyond the lifestyle small business, but no potential to be breakout hits. Is there already a name for this kind of funding?

tptacek 11y ago
I don't understand. The "model" isn't the creation of venture capitalists; it's just mathematical reality. Whether you're shooting for 2x or 10x returns, the odds-on bet is that your company will fail. That's what new companies do. It's true of tech companies, barber shops, and restaurants. In a cohort of failing companies, the returns from successes must be higher to subsidize the losers.
- vonmoltke 11y ago
  > The "model" isn't the creation of venture capitalists; it's just mathematical reality. Only if you invest in startups they way you play craps. The statistical distribution of outcomes is not predictive of the chances of a particular startup succeeding or failing. Some founding teams are virtually guaranteed to fail; some have a better than even chance to succeed. If you are willing to give up on the unicorns you can also eliminate most of the duds. Valley VCs are not willing to do that.
  - tptacek 11y ago
    No, that's the model for firms with expertise in valuing companies. It's very trendy to suggest that big venture capital firms are throwing darts, but in fact they are competing for the best deals (which is another reason crowdfunding investors are at a disadvantage) and for the most part they are not spectacularly successful. Venture capital firms aren't competing for "unicorns" simply out of vanity. They need to bet on firms with outsized returns because even in a cohort of pedigreed startups with plausible business plans and some degree of traction, most are going to fail. Many of those failures are capable of generating reasonable incomes for employees and founders for years, but those incomes are not proxies for investment returns. That's another reason crowdfunding is dangerous: we have a skewed idea of "success", because to us, starting a company that lets us control our own destiny, build our resume, and earn a competitive salary for 10 years is a huge success. To a crowdfunding investor, the returns to investors are the only thing that matters.
    - vonmoltke 11y ago
      > Many of those failures are capable of generating reasonable incomes for employees and founders for years, but those incomes are not proxies for investment returns. That's part of my point. The current VC model causes failures of businesses that are viable going concerns, but not growing fast enough. They know they can make more overall by pushing a subset of those business to explode at the cost of killing most of the others. This also allows them to increase the velocity of their investments, further pressuring their startups to grow or fail fast. Their "cohort of pedigreed startups with plausible business plans and some degree of traction" should yield enough moderate successes to make investment profitable, as long as they are willing to play the long game. Also, those incomes become proxies for investment returns once the company is stable enough to start paying distributions to its owners. Again, though, that ties up capital for the long term, which is anathema to the current VC crowd.
      - tptacek 11y ago
        You're not rebutting me, but rather proving my point about how skewed definitions of "success" harm equity crowdfunding investors. There is in fact very little value of a "going concern" to outside investors. These "going concerns" are successes for people directly involved, but are not successes for investors. Consider that distributions are the normal way partners and LLC members get paid, and also a huge source of lawsuits, because when management is just a small fraction of ownership, their incentives are to minimize distributions. You will find few people on HN more pro-boostrap and anti-VC than me. My last company bootstrapped and ran 10+ years. We're bootstrapping this one. I agree with everything Pinboard says about investment versus funding from customer revenue. But those arguments only have merit as long as you aren't taking outside money to build the business. As soon as you take outside money, your business plan must make sense to the investors.
        jbert 11y ago
        > your business plan must make sense to the investors. Would locking in dividends in the business plan allow the investors to become "directly involved" and make investment in a "going concern but not a unicorn" a rational choice for an investor?
- khaolak 11y ago
  I'll try to help you understand the parent's point. The current environment of VC-backed companies is such that almost all companies in the tech startup ecosystem are following high-risk, high-reward paths. Barber shops and restaurants tend not to do this - they follow low-risk, low-reward paths. One reason for this is how they are funded - a bank giving a business loan for a restaurant might want to see a conservative plan to make one restaurant profitable within a few months of opening, to maximize the likelihood that their loan is repaid. If there was a VC backed restaurant with equity financing, they might instead try to grow rapidly to a thousand locations to try to displace/disrupt McDonalds, all while losing money for several years, in the hope that they end up a multi-billion dollar chain. Obviously this is much more likely to fail and be worth nothing. By adding a new form of funding that sits between a business loan and a VC equity deal, the hope is that you also create a new space of business plans that are more aggressive than the single-restaurant with debt plan but less aggressive than the "try to take on McDonalds" plan.
  - tptacek 11y ago
    I understand the utility of that middle ground but not how equity crowdfunding provides it. The issue here is the failure rate for companies. Good companies fail routinely, and that includes companies that aren't on 100x trajectories. The high rate of failure requires higher returns from the winners. Accounting for realistic failure rates, I simply don't see how you can build a model that makes 2x returns from winners workable for outside investors.

tptacek 11y ago

I don't understand. The "model" isn't the creation of venture capitalists; it's just mathematical reality. Whether you're shooting for 2x or 10x returns, the odds-on bet is that your company will fail. That's what new companies do. It's true of tech companies, barber shops, and restaurants. In a cohort of failing companies, the returns from successes must be higher to subsidize the losers.

vonmoltke 11y ago
> The "model" isn't the creation of venture capitalists; it's just mathematical reality. Only if you invest in startups they way you play craps. The statistical distribution of outcomes is not predictive of the chances of a particular startup succeeding or failing. Some founding teams are virtually guaranteed to fail; some have a better than even chance to succeed. If you are willing to give up on the unicorns you can also eliminate most of the duds. Valley VCs are not willing to do that.
- tptacek 11y ago
  No, that's the model for firms with expertise in valuing companies. It's very trendy to suggest that big venture capital firms are throwing darts, but in fact they are competing for the best deals (which is another reason crowdfunding investors are at a disadvantage) and for the most part they are not spectacularly successful. Venture capital firms aren't competing for "unicorns" simply out of vanity. They need to bet on firms with outsized returns because even in a cohort of pedigreed startups with plausible business plans and some degree of traction, most are going to fail. Many of those failures are capable of generating reasonable incomes for employees and founders for years, but those incomes are not proxies for investment returns. That's another reason crowdfunding is dangerous: we have a skewed idea of "success", because to us, starting a company that lets us control our own destiny, build our resume, and earn a competitive salary for 10 years is a huge success. To a crowdfunding investor, the returns to investors are the only thing that matters.
  - vonmoltke 11y ago
    > Many of those failures are capable of generating reasonable incomes for employees and founders for years, but those incomes are not proxies for investment returns. That's part of my point. The current VC model causes failures of businesses that are viable going concerns, but not growing fast enough. They know they can make more overall by pushing a subset of those business to explode at the cost of killing most of the others. This also allows them to increase the velocity of their investments, further pressuring their startups to grow or fail fast. Their "cohort of pedigreed startups with plausible business plans and some degree of traction" should yield enough moderate successes to make investment profitable, as long as they are willing to play the long game. Also, those incomes become proxies for investment returns once the company is stable enough to start paying distributions to its owners. Again, though, that ties up capital for the long term, which is anathema to the current VC crowd.
    - tptacek 11y ago
      You're not rebutting me, but rather proving my point about how skewed definitions of "success" harm equity crowdfunding investors. There is in fact very little value of a "going concern" to outside investors. These "going concerns" are successes for people directly involved, but are not successes for investors. Consider that distributions are the normal way partners and LLC members get paid, and also a huge source of lawsuits, because when management is just a small fraction of ownership, their incentives are to minimize distributions. You will find few people on HN more pro-boostrap and anti-VC than me. My last company bootstrapped and ran 10+ years. We're bootstrapping this one. I agree with everything Pinboard says about investment versus funding from customer revenue. But those arguments only have merit as long as you aren't taking outside money to build the business. As soon as you take outside money, your business plan must make sense to the investors.
      - jbert 11y ago
        > your business plan must make sense to the investors. Would locking in dividends in the business plan allow the investors to become "directly involved" and make investment in a "going concern but not a unicorn" a rational choice for an investor?
khaolak 11y ago
I'll try to help you understand the parent's point. The current environment of VC-backed companies is such that almost all companies in the tech startup ecosystem are following high-risk, high-reward paths. Barber shops and restaurants tend not to do this - they follow low-risk, low-reward paths. One reason for this is how they are funded - a bank giving a business loan for a restaurant might want to see a conservative plan to make one restaurant profitable within a few months of opening, to maximize the likelihood that their loan is repaid. If there was a VC backed restaurant with equity financing, they might instead try to grow rapidly to a thousand locations to try to displace/disrupt McDonalds, all while losing money for several years, in the hope that they end up a multi-billion dollar chain. Obviously this is much more likely to fail and be worth nothing. By adding a new form of funding that sits between a business loan and a VC equity deal, the hope is that you also create a new space of business plans that are more aggressive than the single-restaurant with debt plan but less aggressive than the "try to take on McDonalds" plan.
- tptacek 11y ago
  I understand the utility of that middle ground but not how equity crowdfunding provides it. The issue here is the failure rate for companies. Good companies fail routinely, and that includes companies that aren't on 100x trajectories. The high rate of failure requires higher returns from the winners. Accounting for realistic failure rates, I simply don't see how you can build a model that makes 2x returns from winners workable for outside investors.