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A much simpler and cleaner analysis: risk-return divergence. Investors manage portfolios and fund returns are dominated by the home runs. Therefore, investor

by 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).
kriro 10y ago
I wonder if this dominance of the home runs is a self fulfilling prophecy though. VCs want to back the home runs and thus they kind of force their entire portfolio into the procrustean bed of hyper growth strategies. Some of the busts might only bust because they falsely follow the common hyper growth patterns. I don't think it would be a horrible idea for some of the bigger funds to set up a separate "race to profitability" fund where the explicit goal of the companies is to be profitable as soon as possible. You could even hold on to the winners from this fund long term instead of selling your equity share and aiming for the magic exit and infuse the generated profits into the fund. Could be a great learning exercise and also a decent instrument to have for the normal fund. I can very well see a "hard talk" where VCs tell one of their normal portfolio companies...look we think your basically a bust and will transfer you to the other fund where you have N time to become profitable on a smaller scale. Thankfully we have some experts there who can trim the hyper growth engine off your company and help you focus on smaller level profitability.

by payne92 10y ago

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).

kriro 10y ago

I wonder if this dominance of the home runs is a self fulfilling prophecy though. VCs want to back the home runs and thus they kind of force their entire portfolio into the procrustean bed of hyper growth strategies. Some of the busts might only bust because they falsely follow the common hyper growth patterns. I don't think it would be a horrible idea for some of the bigger funds to set up a separate "race to profitability" fund where the explicit goal of the companies is to be profitable as soon as possible. You could even hold on to the winners from this fund long term instead of selling your equity share and aiming for the magic exit and infuse the generated profits into the fund. Could be a great learning exercise and also a decent instrument to have for the normal fund. I can very well see a "hard talk" where VCs tell one of their normal portfolio companies...look we think your basically a bust and will transfer you to the other fund where you have N time to become profitable on a smaller scale. Thankfully we have some experts there who can trim the hyper growth engine off your company and help you focus on smaller level profitability.