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Why VCs sometimes push companies to burn too fast

165 points by craigcannon 10y ago

akharris 10y ago
Author here - curious if you've seen this happen.
- jaf12duke 10y ago
  You have the dynamic mostly correct, but the motivations reside more at the partner level than the VC firm level. Individual partner IRRs are determined by the mark up they can report for the specific deals on which they have attribution. When a VC pushes for a faster burn which then necessitates a new VC firm to fund the next round (perhaps prematurely relative to the founder's perspective), it's so that that individual VC can mark up their personal IRR. Which may be relevant to their firm and the firm's fundraising plans to LPs. But could also be even more relevant if that partner is thinking about changing firms or starting his/her fund own. Individual IRR, based on deals with attribution, is the resume of a VC. The effect of this is, junior partners push for this type of behavior more than senior partners that are already set with an impressive personal IRR.
  - akharris 10y ago
    Agree that much of this is partner dependent, but I've seen the dynamic play out happen with senior partners who have great track records and with younger partners out to prove themselves. In each case, I think the motivations differ slightly, but the same theme is at work.
- tommynicholas 10y ago
  Our lead investor actively acknowledges this potential conflict with us in spending/funding conversations so we can all make sure we're conscious of whether it is or isn't happening. One of many reasons I enjoy working with them.
carsongross 10y ago
A more succinct, cynical take: anyone who sells money for equity is always going to be happy to see you need more money. (The author dances around this, for understandable reasons.)
- deleted 10y ago
  [deleted]
- akharris 10y ago
  I understand the cynical take, but having worked with a lot of investors, I don't think it's the dominant reason. If at all possible, investors would rather own a smaller piece of something huge than an ever increasing share of something small. This is actually something you can use when negotiating if someone tells you "I need 20%." Really, they need a big return on their invested dollars. The exact % is just a rule of thumb based on the overall returns they expect from their investments in the context of the entire portfolio.
  - rhizome 10y ago
    So maybe the higher the ask%, the lower their faith in the company?
hitekker 10y ago
> The Worst Case: > The company runs out of money. Actually, the worst case is keeping a company going even though the fundamentals of the business are imprecise, hard-to-define or just plain wrong. You end up wasting resources of all kinds for everyone involved. Investors, employees, and founders, to varying degrees, will squander time, energy, enthusiasm, money in pursuit of a mirage. Money isn't everything, surprisingly, even in a round of funding. If you accept a huge sum of cash with a giant valuation attached, you must have reasonable certainty that you will at some point achieve that valuation without more raising. Mental gymnastics aside, I don't think most startups can guarantee outcomes, but they must be, at least, certain of their motives. Are you raising because you're at the scaling stage? Or are you raising to buy yourself a little bit more time to hopefully, maybe, figure things out? The latter reason is a poor reason to raise, and most of the time, only staves off the inevitable at the cost of unnecessary suffering and hardship.
- CalChris 10y ago
  This is brutal but fair. I'd say it's a good counterpoint to the cynical (and good) summary above. A founder is a fool if they don't think the clock is ticking. Fools don't focus; fools fester. Indeed, the article isn't even talking about putting more money into a worst case scenario; it's talking about founders aggressively using the resources they've been given.
- edblarney 10y ago
  "Investors, employees, and founders, to varying degrees, will squander time, energy, enthusiasm, money in pursuit of a mirage" Most 'employees' will never see any significant upside in any of the startups they've worked at or will work with - so their compensation is their livelihood and not exactly a waste of time. There is a lot of inefficiency at big companies as well, so it's arguable that most tech workers are 'wasting at least some of their time' in the big disorderly march to progress. They are also gaining skills. But I agree it's a pretty bad thing to do to raise money to 'figure things out'. I'd loathe to think of how many of those would actually get funded.
deleted 10y ago
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Animats 10y ago
The zombie problem - same issue I brought up at [1]. Not successful enough to pay back investors, but they won't die. [1] https://news.ycombinator.com/item?id=12981392 https://news.ycombinator.com/item?id=12981392
- danieltillett 10y ago
  I am surprised that VCs don't sell their zombies to specialized turn-around firms or to other investors looking for slower, but more steady growth.
  - api 10y ago
    Don't some number of acquisitions count as this more or less?
  - ccozan 10y ago
    Is there a list of failed/failing startups and their USP ? Would really like to see such a list, and be able to pick and run it further?
  - dilemma 10y ago
    Private Equity
    - mbesto 10y ago
      This. I've advised on 30+ PE deals involving software companies this past year. Definitely worth looking into if you're a profitable mid market SaaS company.
- TuringNYC 10y ago
  I'm a bit confused by this...wouldn't the interest carry on a convertible note essentially kill a startup that takes too long to reach a liquidity event?
graycat 10y ago
Main theme: The VCs again are not looking carefully at the plans of the company and, instead, are focused just on current traction and maybe the growth rate of that traction. So, the VCs are looking at essentially just accounting measures. That's like betting on race cars without looking at the car engineering. Problem: Using just traction and its rate of growth is a poor way to evaluate the real future of the company. Here's some of how: That approach ignores (A) the size of the market and its growth rate, (B) the core technology and is it defensible or, instead, easy to duplicate or equal, (C) the status of would be competition, (D) the scalability of the technology, (E) the margins once have reached some significant scale, etc. The VCs look like they would really like a drag race car that from a standing start just went 0-100 MPH in 2.5 seconds but 500 feet ahead is headed off a cliff, in another 1/2 second will have the rear tires explode, the supercharger belt fail, or already has the engine at 8000 RPM and in 1/2 second at 10,000 RPM the engine will explode. Why Do VCs Do This: As the OP explains, the VCs have to report back to their LPs quite frequently, and the LPs are looking only for simplistic measures, e.g., from something close to traditional accounting, e.g., would ignore anything about the engineering of a race car. Apparently the VCs and LPs would prefer a lemonade stand that opened just before July 4th and on July 5th can show good traction and fantastic rate of growth in traction. For a safe, effective, cheap one pill that taken once can cure any cancer now in Phase III trials, the information technology VCs would say "No traction" and f'get about it. So, the VCs want an early pop easy to see and measure in simplistic terms. Okay, that can become a game. So, delay all reports of progress. When have accumulated some nice progress in traction, in January say that will have rapid growth starting in March and will have a report on April 1st. Do that, and have the April 1st report look really good on traction and its rate of growth. Then let the VCs report this fantastic exploding success back to the LPs. Information technology VCs just flatly refuse to evaluate projects based on the real internals and, instead, pay attention only to simplistic, visible, external measures. That's foolish. Entrepreneurs beware: Reporting to a BoD of fools is no fun.
- CalChris 10y ago
  I agree with a lot of what you said but would biotech VCs evaluate IT any better? Biotech has really long expensive cycle times from discovery through trials. It's like correspondence chess vs bullet. Not the same, not similar. On biotech, I had a sailing buddy, Cambridge PhD, and I could not understand the motivation of principle engineer level researchers in that field. Maybe it's a job job; I couldn't see any parallel.
huangc10 10y ago
I actually gave this quite some thought after talking with a friend about the up-and-coming startup he was working for. Recently they just received a 20 mil series A funding and yeh...they're burning cash (mass hirings, searching for a new location, etc.). The thing is, the CEO has started his own company twice and sold both (this was his third company) so we both assume he knows what he's doing. In the scenario of the CEO, I feel like his plan is this, and only this: "high risk, high reward" "live fast, die young" Are these the correct thoughts for a serial entrepreneur (who is also sorta like an investor)? *edit, funding was actually for series A not B
- adventured 10y ago
  There is no such thing as objectively "correct thoughts" in this context. There are numerous approaches that can result in success with a start-up. Some people are comfortable with more risk, some people prefer less risk. Sometimes in hindsight a situation that appears high risk, is in fact much lower risk than most observers anticipated (Facebook is an example of that, nearly every valuation stage was widely pronounced to be absurd). As an entrepreneur, I'd argue the best scenario for one's self is make sure the risk you're taking is a relatively close match to your own tolerance for risk (that is, within a reasonable range of your tolerance, not far outside it; the consequences to yourself in terms of stress, quality of life and performance skyrocket the further you get away from that).
  - huangc10 10y ago
    I agree with you. However, there still seems to be a progression (or at least from articles I've read stating that serial entrepreneurs are usually more successful...) It seems that newer entrepreneurs will take less risk (is this true..? that's why I used seems). More seasoned/serial entrepreneurs will just go balls to the wall because they know of the mistakes they've made in the past and know how to be successful. They don't seem to be as scared of failure because they've failed before. Should newer entrepreneurs just skip the progression and go straight to not being afraid and effect mimic more seasoned peers. Would the chances of success be slightly higher (even a slight higher chance of success is worth it...)?
- 10y ago
danieltillett 10y ago
I wonder how much of this dynamic is caused by the 10 year fund life? Would VCs respond the same way if the LPs gave them 15 years? Would VCs change the sort of company they invest in?
- greglindahl 10y ago
  In order to raise Fund N+1, a VC firm needs successful exits from Fund N. I had a startup whose exit timing was driven by our investors needing a successful exit so they could raise. A longer-lived fund would not have changed the timing.
  - mason55 10y ago
    Theoretically you could try to shift it so that fund N was based on the exits from fund N-2. That way you don't have to the cohort in N-1 to exit so fast. The only difficulty would be the first couple funds where you'd have to push group 1 to exit so you could raise fund 2, then try to raise fund 3 on the exits of fund 1 plus the growth (but not exits) of fund 2.
    - greglindahl 10y ago
      The investors in question had raised many funds. I suspect their LPs were more interested in "what have you done for me lately" than anything about Fund N-2.
payne92 10y ago
A much simpler and cleaner analysis: risk-return divergence. Investors manage portfolios and fund returns are dominated by the home runs. Therefore, investors generally want to maximize risk (and potential return), which is usually at odds with a founding team with most of their net worth tied up in the company.
- greglindahl 10y ago
  Plenty of people on founding teams like home runs, too.
  - aetherson 10y ago
    Well, of course they do. But what they "like" is a pretty trivial level of analysis. Let's say you invest 5-10 years into a startup. Which would you rather have? A 30% chance at a $10M payday, or a 5% chance at a $100M payday? The answer is not "Well, I'll just repeat until the 5% chance materializes."
    - greglindahl 10y ago
      I'll take the 5%. Makes it easier to raise money. I've done this twice, so you can take my answer as actual and not theoretical.
- gnicholas 10y ago
  Like you, I was surprised that this wasn't part of the author's analysis. VCs are more risk-neutral, due to their diversification. Founders are more risk-averse because they have a stake in just one company. For example, if a company has an 80% chance of getting sold for at least $50M, the founder wants to make sure that happens. A VC is more interested in the 10% chance that the company could sell for $200M and the 2% chance that it will sell for $1B. A faster burn rate doesn't materially impact the VC's odds of "success," because companies destined to be unicorns won't be hurt by a faster burn rate. But burning cash makes it much more likely that the company is sold for scrap instead of hitting the 80% chance of a $50M exit (which means life-changing wealth for most founders).
neom 10y ago
The only VC firm I know who doesn't put loads of pressure onto the foundry/exec to deploy capital is a16z, or at least the partners I know of and/or founders I know who have worked with them seem to have not felt that pressure. I always thought this was both annoying and pretty useful. On one hand, if you're building a sustainable business and you're in the growth stage, you're simply going to market, and so that can take as long as it takes (if the market is nascent, maybe you're waiting for it to mature etc), and that's nice. On the other hand, I've seen founders get so wrapped up in building the company they forget to build the business, or so wrapped up in building the business they forget to build the company, if you're under the gun of investing capital, you have to stay pretty focused on your real revenue. Forgetting to focusing on real revenue can be pretty easy when you're well funded and know you have big pro-ratas/names behind you who won't tank an investment. If you're in the MVP stage, founders who don't burn and burn quickly are probably doing it wrong, as an MVP may not be a business yet, and if it is, it's almost certainly not geared to operate at scale. IMO seed/mvp should burn consistently and quite quickly, growth stage should burn very planned and systematically.
paulsutter 10y ago
> Conversely, companies that fail remove themselves as a time commitment for a partner If you look at the portfolio of a VC fund you'll see why. If they're in 45 companies, essentially all the return will come from 3-5 companies. The other 40 board seats are a hassle. Whether they return 0x or 2x, they're just not material to the success of the fund.
lpolovets 10y ago
I'm a VC. I think a lot of this boils down to the asymmetric relationship between the upside and the downside. If a company doesn't do well, the investor loses all/most of their investment. It doesn't matter how ambitiously or unambitiously the startup acted, the VC's losses are roughly fixed. On the other hand, the difference between a company having a very good (e.g. 8x) vs. fantastic (e.g. 50x) outcome is huge. If increasing burn helps a company grow faster, acquire more market share, and improves the chances that the company will 50x instead of 8x, then that's worth a higher chance of failure to the VC because they have some diversification. It may or may not be worth it to the founders, who only work on one startup at a time. So basically, if the two possible scenarios are the following.. 1) 60% chance to 0x, 30% chance to 3x, 10% chance to 8x 2) 80% chance to 0x, 15% chance to 3x, 5% chance to 50x .. then VCs strongly prefer the second scenario. There's a slightly higher chance of a loss, but the upside is much, much greater.
- kordless 10y ago
  A preference to viral models, backed by unbounded trust, sets the intent (rules of the game) to produce viral business models at the direct expense of less viral, but more holistic customer-centric models. Investing in high growth models seems like a great idea when sitting around drinking beer, but I'm willing to bet the long term effect of this practice is going to come back and bite us in the ass sooner than later, if it hasn't already. There's a reason why seaweed reduces cow gas. We have to use seaweed on cows now because we removed the cows from the grass. There's a similar reason behind why our privacy has been thrown out with the bathwater!
- didgeoridoo 10y ago
  Given the expected values in your example, I don't think anyone would fault a VC (or any actor with a non-pathological marginal utility curve) for taking option 2. Now, what about the two bets: 1) 80% 1x, 20% 5x (EV: 1.8x) 2) 99% 0x, 1% 100x (EV: 1.0x) How many VCs do you know who would take 1 over 2, even though it's the "obvious" money-winning bet? I'd love your thoughts on why this is. My semi-cynical thesis is that VCs need home-run logos on the Portfolio page of their website to keep their spot at the dealflow table. Let's break the VC world up into three types: A - Brand-name VCs that funded yesterday's massive unicorns, and are regarded as clairvoyant masters of the universe B - Unknown VCs with a half-decent return on their last fund, but didn't back anyone you've heard of C - VCs that swung for the fences a few too many times and imploded Founders want to work with "A" VCs (for both rational and irrational reasons), so the first names they call are the ones whose past big bets paid off. "B" VCs are much lower on the call list, and only get access to the deals that "A" VCs all passed on. "C" VCs are obviously not available to chat. It is arguably rational for a VC to seek to become an "A" and end up as a "C", rather than to muddle along as a "B" until she's getting pitched every week by hair salon and gym owners with A Great App Idea and her LPs wonder what she's doing with their money.
djyaz1200 10y ago
VC's want your company to quickly "Blow up" one way or another.
fanzhang 10y ago
Can a lot of this be distilled into differing risk aversions between the investors and the founders? Two major reasons here seem to be 1) VCs not wanting to sink time into a failing startup (force downside) and 2) markups in valuation are preferred by VCs (force upside). But directionally these incentives are the same for founders. Founders probably want to work less if their startup is failing (per person*years they put in). Founders also prefer the case where they're valued a lot and worth a lot. Magnitude-wise these motivations are very different between founders and investors. For founders, a failure means lost years of their lives -- forcing a downside is a lot more painful. Founders also celebrate the home-run as much as the VCs (in fact probably for the biggest home runs, the founders get out more than an individual VC right?). This could create an asymmetry whereby founders are in no hurry if hurry could mean failure, and the model above is classical risk aversion. Conversely, VCs don't mind that much if your chance of failure goes up by a few percentage points. Aaron also tacks on some new ingredients: VCs like to see markups for it's own sake (to solve the monitoring problem between LPs and VCs). I have no doubt with his experience the mechanisms are absolutely correct, just wondering if the majority of the underlying generator of these symptoms is underlying risk aversion.
kriro 10y ago
Are there really no small ball (in the Moneyball sense) VCs? It seems like there could even be a market for taking the ok but never great companies off the hands of boom/bust mentality funds at fairly good conditions.
- anandkulkarni 10y ago
  Dave McClure laid out a model for playing Moneyball on startups – investing well before product/market fit, when other VCs didn't see value. Today, that's 500 Startups. http://500hats.typepad.com/500blogs/2010/07/moneyball-for-startups.html http://500hats.typepad.com/500blogs/2010/07/moneyball-for-st...
- deleted 10y ago
  [deleted]

165 points by craigcannon 10y ago

akharris 10y ago

Author here - curious if you've seen this happen.

jaf12duke 10y ago
You have the dynamic mostly correct, but the motivations reside more at the partner level than the VC firm level. Individual partner IRRs are determined by the mark up they can report for the specific deals on which they have attribution. When a VC pushes for a faster burn which then necessitates a new VC firm to fund the next round (perhaps prematurely relative to the founder's perspective), it's so that that individual VC can mark up their personal IRR. Which may be relevant to their firm and the firm's fundraising plans to LPs. But could also be even more relevant if that partner is thinking about changing firms or starting his/her fund own. Individual IRR, based on deals with attribution, is the resume of a VC. The effect of this is, junior partners push for this type of behavior more than senior partners that are already set with an impressive personal IRR.
- akharris 10y ago
  Agree that much of this is partner dependent, but I've seen the dynamic play out happen with senior partners who have great track records and with younger partners out to prove themselves. In each case, I think the motivations differ slightly, but the same theme is at work.
tommynicholas 10y ago
Our lead investor actively acknowledges this potential conflict with us in spending/funding conversations so we can all make sure we're conscious of whether it is or isn't happening. One of many reasons I enjoy working with them.

carsongross 10y ago

A more succinct, cynical take: anyone who sells money for equity is always going to be happy to see you need more money. (The author dances around this, for understandable reasons.)

deleted 10y ago
[deleted]
akharris 10y ago
I understand the cynical take, but having worked with a lot of investors, I don't think it's the dominant reason. If at all possible, investors would rather own a smaller piece of something huge than an ever increasing share of something small. This is actually something you can use when negotiating if someone tells you "I need 20%." Really, they need a big return on their invested dollars. The exact % is just a rule of thumb based on the overall returns they expect from their investments in the context of the entire portfolio.
- rhizome 10y ago
  So maybe the higher the ask%, the lower their faith in the company?

hitekker 10y ago

> The Worst Case: > The company runs out of money. Actually, the worst case is keeping a company going even though the fundamentals of the business are imprecise, hard-to-define or just plain wrong. You end up wasting resources of all kinds for everyone involved. Investors, employees, and founders, to varying degrees, will squander time, energy, enthusiasm, money in pursuit of a mirage. Money isn't everything, surprisingly, even in a round of funding. If you accept a huge sum of cash with a giant valuation attached, you must have reasonable certainty that you will at some point achieve that valuation without more raising. Mental gymnastics aside, I don't think most startups can guarantee outcomes, but they must be, at least, certain of their motives. Are you raising because you're at the scaling stage? Or are you raising to buy yourself a little bit more time to hopefully, maybe, figure things out? The latter reason is a poor reason to raise, and most of the time, only staves off the inevitable at the cost of unnecessary suffering and hardship.

CalChris 10y ago
This is brutal but fair. I'd say it's a good counterpoint to the cynical (and good) summary above. A founder is a fool if they don't think the clock is ticking. Fools don't focus; fools fester. Indeed, the article isn't even talking about putting more money into a worst case scenario; it's talking about founders aggressively using the resources they've been given.
edblarney 10y ago
"Investors, employees, and founders, to varying degrees, will squander time, energy, enthusiasm, money in pursuit of a mirage" Most 'employees' will never see any significant upside in any of the startups they've worked at or will work with - so their compensation is their livelihood and not exactly a waste of time. There is a lot of inefficiency at big companies as well, so it's arguable that most tech workers are 'wasting at least some of their time' in the big disorderly march to progress. They are also gaining skills. But I agree it's a pretty bad thing to do to raise money to 'figure things out'. I'd loathe to think of how many of those would actually get funded.

deleted 10y ago

[deleted]

Animats 10y ago

The zombie problem - same issue I brought up at [1]. Not successful enough to pay back investors, but they won't die. [1] https://news.ycombinator.com/item?id=12981392 https://news.ycombinator.com/item?id=12981392

danieltillett 10y ago
I am surprised that VCs don't sell their zombies to specialized turn-around firms or to other investors looking for slower, but more steady growth.
- api 10y ago
  Don't some number of acquisitions count as this more or less?
- ccozan 10y ago
  Is there a list of failed/failing startups and their USP ? Would really like to see such a list, and be able to pick and run it further?
- dilemma 10y ago
  Private Equity
  - mbesto 10y ago
    This. I've advised on 30+ PE deals involving software companies this past year. Definitely worth looking into if you're a profitable mid market SaaS company.
TuringNYC 10y ago
I'm a bit confused by this...wouldn't the interest carry on a convertible note essentially kill a startup that takes too long to reach a liquidity event?

graycat 10y ago

Main theme: The VCs again are not looking carefully at the plans of the company and, instead, are focused just on current traction and maybe the growth rate of that traction. So, the VCs are looking at essentially just accounting measures. That's like betting on race cars without looking at the car engineering. Problem: Using just traction and its rate of growth is a poor way to evaluate the real future of the company. Here's some of how: That approach ignores (A) the size of the market and its growth rate, (B) the core technology and is it defensible or, instead, easy to duplicate or equal, (C) the status of would be competition, (D) the scalability of the technology, (E) the margins once have reached some significant scale, etc. The VCs look like they would really like a drag race car that from a standing start just went 0-100 MPH in 2.5 seconds but 500 feet ahead is headed off a cliff, in another 1/2 second will have the rear tires explode, the supercharger belt fail, or already has the engine at 8000 RPM and in 1/2 second at 10,000 RPM the engine will explode. Why Do VCs Do This: As the OP explains, the VCs have to report back to their LPs quite frequently, and the LPs are looking only for simplistic measures, e.g., from something close to traditional accounting, e.g., would ignore anything about the engineering of a race car. Apparently the VCs and LPs would prefer a lemonade stand that opened just before July 4th and on July 5th can show good traction and fantastic rate of growth in traction. For a safe, effective, cheap one pill that taken once can cure any cancer now in Phase III trials, the information technology VCs would say "No traction" and f'get about it. So, the VCs want an early pop easy to see and measure in simplistic terms. Okay, that can become a game. So, delay all reports of progress. When have accumulated some nice progress in traction, in January say that will have rapid growth starting in March and will have a report on April 1st. Do that, and have the April 1st report look really good on traction and its rate of growth. Then let the VCs report this fantastic exploding success back to the LPs. Information technology VCs just flatly refuse to evaluate projects based on the real internals and, instead, pay attention only to simplistic, visible, external measures. That's foolish. Entrepreneurs beware: Reporting to a BoD of fools is no fun.

CalChris 10y ago
I agree with a lot of what you said but would biotech VCs evaluate IT any better? Biotech has really long expensive cycle times from discovery through trials. It's like correspondence chess vs bullet. Not the same, not similar. On biotech, I had a sailing buddy, Cambridge PhD, and I could not understand the motivation of principle engineer level researchers in that field. Maybe it's a job job; I couldn't see any parallel.

huangc10 10y ago

I actually gave this quite some thought after talking with a friend about the up-and-coming startup he was working for. Recently they just received a 20 mil series A funding and yeh...they're burning cash (mass hirings, searching for a new location, etc.). The thing is, the CEO has started his own company twice and sold both (this was his third company) so we both assume he knows what he's doing. In the scenario of the CEO, I feel like his plan is this, and only this: "high risk, high reward" "live fast, die young" Are these the correct thoughts for a serial entrepreneur (who is also sorta like an investor)? *edit, funding was actually for series A not B

adventured 10y ago
There is no such thing as objectively "correct thoughts" in this context. There are numerous approaches that can result in success with a start-up. Some people are comfortable with more risk, some people prefer less risk. Sometimes in hindsight a situation that appears high risk, is in fact much lower risk than most observers anticipated (Facebook is an example of that, nearly every valuation stage was widely pronounced to be absurd). As an entrepreneur, I'd argue the best scenario for one's self is make sure the risk you're taking is a relatively close match to your own tolerance for risk (that is, within a reasonable range of your tolerance, not far outside it; the consequences to yourself in terms of stress, quality of life and performance skyrocket the further you get away from that).
- huangc10 10y ago
  I agree with you. However, there still seems to be a progression (or at least from articles I've read stating that serial entrepreneurs are usually more successful...) It seems that newer entrepreneurs will take less risk (is this true..? that's why I used seems). More seasoned/serial entrepreneurs will just go balls to the wall because they know of the mistakes they've made in the past and know how to be successful. They don't seem to be as scared of failure because they've failed before. Should newer entrepreneurs just skip the progression and go straight to not being afraid and effect mimic more seasoned peers. Would the chances of success be slightly higher (even a slight higher chance of success is worth it...)?
10y ago

danieltillett 10y ago

I wonder how much of this dynamic is caused by the 10 year fund life? Would VCs respond the same way if the LPs gave them 15 years? Would VCs change the sort of company they invest in?

greglindahl 10y ago
In order to raise Fund N+1, a VC firm needs successful exits from Fund N. I had a startup whose exit timing was driven by our investors needing a successful exit so they could raise. A longer-lived fund would not have changed the timing.
- mason55 10y ago
  Theoretically you could try to shift it so that fund N was based on the exits from fund N-2. That way you don't have to the cohort in N-1 to exit so fast. The only difficulty would be the first couple funds where you'd have to push group 1 to exit so you could raise fund 2, then try to raise fund 3 on the exits of fund 1 plus the growth (but not exits) of fund 2.
  - greglindahl 10y ago
    The investors in question had raised many funds. I suspect their LPs were more interested in "what have you done for me lately" than anything about Fund N-2.

payne92 10y ago

A much simpler and cleaner analysis: risk-return divergence. Investors manage portfolios and fund returns are dominated by the home runs. Therefore, investors generally want to maximize risk (and potential return), which is usually at odds with a founding team with most of their net worth tied up in the company.

greglindahl 10y ago
Plenty of people on founding teams like home runs, too.
- aetherson 10y ago
  Well, of course they do. But what they "like" is a pretty trivial level of analysis. Let's say you invest 5-10 years into a startup. Which would you rather have? A 30% chance at a $10M payday, or a 5% chance at a $100M payday? The answer is not "Well, I'll just repeat until the 5% chance materializes."
  - greglindahl 10y ago
    I'll take the 5%. Makes it easier to raise money. I've done this twice, so you can take my answer as actual and not theoretical.
gnicholas 10y ago
Like you, I was surprised that this wasn't part of the author's analysis. VCs are more risk-neutral, due to their diversification. Founders are more risk-averse because they have a stake in just one company. For example, if a company has an 80% chance of getting sold for at least $50M, the founder wants to make sure that happens. A VC is more interested in the 10% chance that the company could sell for $200M and the 2% chance that it will sell for $1B. A faster burn rate doesn't materially impact the VC's odds of "success," because companies destined to be unicorns won't be hurt by a faster burn rate. But burning cash makes it much more likely that the company is sold for scrap instead of hitting the 80% chance of a $50M exit (which means life-changing wealth for most founders).

neom 10y ago

The only VC firm I know who doesn't put loads of pressure onto the foundry/exec to deploy capital is a16z, or at least the partners I know of and/or founders I know who have worked with them seem to have not felt that pressure. I always thought this was both annoying and pretty useful. On one hand, if you're building a sustainable business and you're in the growth stage, you're simply going to market, and so that can take as long as it takes (if the market is nascent, maybe you're waiting for it to mature etc), and that's nice. On the other hand, I've seen founders get so wrapped up in building the company they forget to build the business, or so wrapped up in building the business they forget to build the company, if you're under the gun of investing capital, you have to stay pretty focused on your real revenue. Forgetting to focusing on real revenue can be pretty easy when you're well funded and know you have big pro-ratas/names behind you who won't tank an investment. If you're in the MVP stage, founders who don't burn and burn quickly are probably doing it wrong, as an MVP may not be a business yet, and if it is, it's almost certainly not geared to operate at scale. IMO seed/mvp should burn consistently and quite quickly, growth stage should burn very planned and systematically.

paulsutter 10y ago

> Conversely, companies that fail remove themselves as a time commitment for a partner If you look at the portfolio of a VC fund you'll see why. If they're in 45 companies, essentially all the return will come from 3-5 companies. The other 40 board seats are a hassle. Whether they return 0x or 2x, they're just not material to the success of the fund.

lpolovets 10y ago

I'm a VC. I think a lot of this boils down to the asymmetric relationship between the upside and the downside. If a company doesn't do well, the investor loses all/most of their investment. It doesn't matter how ambitiously or unambitiously the startup acted, the VC's losses are roughly fixed. On the other hand, the difference between a company having a very good (e.g. 8x) vs. fantastic (e.g. 50x) outcome is huge. If increasing burn helps a company grow faster, acquire more market share, and improves the chances that the company will 50x instead of 8x, then that's worth a higher chance of failure to the VC because they have some diversification. It may or may not be worth it to the founders, who only work on one startup at a time. So basically, if the two possible scenarios are the following.. 1) 60% chance to 0x, 30% chance to 3x, 10% chance to 8x 2) 80% chance to 0x, 15% chance to 3x, 5% chance to 50x .. then VCs strongly prefer the second scenario. There's a slightly higher chance of a loss, but the upside is much, much greater.

kordless 10y ago
A preference to viral models, backed by unbounded trust, sets the intent (rules of the game) to produce viral business models at the direct expense of less viral, but more holistic customer-centric models. Investing in high growth models seems like a great idea when sitting around drinking beer, but I'm willing to bet the long term effect of this practice is going to come back and bite us in the ass sooner than later, if it hasn't already. There's a reason why seaweed reduces cow gas. We have to use seaweed on cows now because we removed the cows from the grass. There's a similar reason behind why our privacy has been thrown out with the bathwater!
didgeoridoo 10y ago
Given the expected values in your example, I don't think anyone would fault a VC (or any actor with a non-pathological marginal utility curve) for taking option 2. Now, what about the two bets: 1) 80% 1x, 20% 5x (EV: 1.8x) 2) 99% 0x, 1% 100x (EV: 1.0x) How many VCs do you know who would take 1 over 2, even though it's the "obvious" money-winning bet? I'd love your thoughts on why this is. My semi-cynical thesis is that VCs need home-run logos on the Portfolio page of their website to keep their spot at the dealflow table. Let's break the VC world up into three types: A - Brand-name VCs that funded yesterday's massive unicorns, and are regarded as clairvoyant masters of the universe B - Unknown VCs with a half-decent return on their last fund, but didn't back anyone you've heard of C - VCs that swung for the fences a few too many times and imploded Founders want to work with "A" VCs (for both rational and irrational reasons), so the first names they call are the ones whose past big bets paid off. "B" VCs are much lower on the call list, and only get access to the deals that "A" VCs all passed on. "C" VCs are obviously not available to chat. It is arguably rational for a VC to seek to become an "A" and end up as a "C", rather than to muddle along as a "B" until she's getting pitched every week by hair salon and gym owners with A Great App Idea and her LPs wonder what she's doing with their money.

djyaz1200 10y ago

VC's want your company to quickly "Blow up" one way or another.

fanzhang 10y ago

Can a lot of this be distilled into differing risk aversions between the investors and the founders? Two major reasons here seem to be 1) VCs not wanting to sink time into a failing startup (force downside) and 2) markups in valuation are preferred by VCs (force upside). But directionally these incentives are the same for founders. Founders probably want to work less if their startup is failing (per person*years they put in). Founders also prefer the case where they're valued a lot and worth a lot. Magnitude-wise these motivations are very different between founders and investors. For founders, a failure means lost years of their lives -- forcing a downside is a lot more painful. Founders also celebrate the home-run as much as the VCs (in fact probably for the biggest home runs, the founders get out more than an individual VC right?). This could create an asymmetry whereby founders are in no hurry if hurry could mean failure, and the model above is classical risk aversion. Conversely, VCs don't mind that much if your chance of failure goes up by a few percentage points. Aaron also tacks on some new ingredients: VCs like to see markups for it's own sake (to solve the monitoring problem between LPs and VCs). I have no doubt with his experience the mechanisms are absolutely correct, just wondering if the majority of the underlying generator of these symptoms is underlying risk aversion.

kriro 10y ago

Are there really no small ball (in the Moneyball sense) VCs? It seems like there could even be a market for taking the ok but never great companies off the hands of boom/bust mentality funds at fairly good conditions.

anandkulkarni 10y ago
Dave McClure laid out a model for playing Moneyball on startups – investing well before product/market fit, when other VCs didn't see value. Today, that's 500 Startups. http://500hats.typepad.com/500blogs/2010/07/moneyball-for-startups.html http://500hats.typepad.com/500blogs/2010/07/moneyball-for-st...
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