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Here's that I posted on his blog: I agree with a lot of this... But VCs aren't going to change (and it isn't really in their interest to do so). VCs ONLY win

Here's that I posted on his blog: I agree with a lot of this... But VCs aren't going to change (and it isn't really in their interest to do so). VCs ONLY win in two cases-- someone buys the company or the company IPOs. Sustained modest growth rarely gets you to that destination. It's not irrational for VCs to push for growth at the expense of revenue/profit. For their "business model" (the hits in their portfolio paying for all of the duds), it makes perfect sense. I suspect that if a VC tried a new model (focusing on sustainable growth and revenue/profit), they'd find that they'd have a healthier portfolio that was largely illiquid.

parker 19y ago
>> I suspect that if a VC tried a new model (focusing on sustainable growth and revenue/profit), they'd find that they'd have a healthier portfolio that was largely illiquid. Well, if VCs were to concentrate on sustainable growth and profits, maybe we'd see a resurgence of the flacid IPO market. It wasn't too long ago that tech entrepreneurs were motivated to make profits which then allowed them to take their companies public. Seqouia would not have made a crazy-multiple on their investment if Google had focused on being bought pre-revenue in preference over creating profits and taking themselves public. Google's IPO absolutely dwarfs YouTube's acquisition. I think a VC model encouraging profits over growth would be a healthy thing for everyone!
nostrademons 19y ago
Something I'm curious about: what if VCs worked like Berkshire Hathaway, reinvesting the cash thrown off by portfolio businesses but never selling their shares? Profitable businesses all generate return-on-capital; that cash can be reinvested to get new businesses off the ground. It seems like this would be a good model for seed-funding businesses like YC to try, because they've got many more at-bats than big VCs. It might be hard for a big VC firm to generate enough cash for this: if the average investment is $5M, they take 50% of the company, and 90% of their investments fail, then their "hit" needs to churn off $100M in profits to sustain the next round of startups. But if you target hundreds of niche businesses, your investment is $20K, you take 10% of the company, and 50% of the companies survive, then they only need to spin off $400K/year in profits to fund the next round. That seems a lot more achievable. Then again, one of the reasons Berkshire is successful is that Buffett refuses to invest in businesses that don't have predictable streams of cashflow. Startups are anything but predictable, so maybe the model's fundamentally flawed when it comes to startups.
- webwright 19y ago
  "Something I'm curious about: what if VCs worked like Berkshire Hathaway, reinvesting the cash thrown off by portfolio businesses but never selling their shares?" How does cash get thrown off? Are you suggesting a "dividends off of profits" type of thing for growth companies? Aren't growth companies supposed to be reinvesting profits in their own growth? The problem with dividends is that they are really only good one the initial investment is liquid. So if Berkshire invests in a value company that throws off 3% dividends per quarter, that's great. But it's only great because they can get their cash out at any time. If a VC invests in a startup (say $1mm), how exciting is the prospect of 50% chance of failure, but a possible 3% quarterly dividend IF the company succeeds? With no actual market to sell their initial investment of $1mm? I can't make these numbers look attractive in my head.
  - nostrademons 19y ago
    "Are you suggesting a "dividends off of profits" type of thing for growth companies? Aren't growth companies supposed to be reinvesting profits in their own growth?" Yeah, dividends-off-profits. The growth-company thing is an issue for the initial ramp-up phase: it'd probably be 10 years or so before the fund would start having additional capital to invest. But in the steady-state, older non-growing businesses throw off cash that can be reinvested in small growth businesses. "So if Berkshire invests in a value company that throws off 3% dividends per quarter, that's great. But it's only great because they can get their cash out at any time." Berkshire can't cash out of their value companies at any time. Their typical modus operandi is to buy 80% of a successful privately-held business, leaving the other 20% to the founders. The companies remain privately held, and their stock is not sold on the open market. The only way Berkshire can cash out is if they find another buyer, like a private equity firm or large conglomerate, to take the whole business off their hands at once. Also, dividends thrown off by private companies are often a lot more than 3% (public companies have such lousy dividends largely because shareholders lack bargaining power). Take See's Candy, one of Berkshire's early acquisitions (http://valueinvestingresource.blogspot.com/2008/03/sees-candy-magic-formula-stock-from.html http://valueinvestingresource.blogspot.com/2008/03/sees-cand...). They bought it in 1972 for $25M on earnings of $5M. Since then, See's has required capital infusions of $32M and spun off dividends of $1.35B. That's a dividend-to-profit ratio of 98%, in comparison to the normal Wall Street averages of 30-50%. Of course, few startup entrepreneurs would be willing to sell 80% of the company from the outset. Berkshire functions in reverse to VC firms, providing liquidity and multi-million-$ payouts to firms that have already gotten successful. But what if you reversed the terms? 10-20% of the equity for the chance to be your own boss? With the investor's dividend payouts protected by a legal clause in the investment documents, guaranteeing that after certain profitability and cash reserve milestones are met and growth has fallen below a certain amount, X% of the profits are distributed as dividends? This is all idle speculation, since I don't have money to put where my mouth is. But if I had a billion dollars or so, I'd definitely want to try it. Because if these assumptions are true: 1.) Startups are the most productive part of the economy 2.) A small initial investment would let many more people quit their day jobs and found startups 3.) Getting bought destroys most of the efficiency advantages of being a startup Then a logical consequence is that a firm that buys-and-holds small profit-oriented startups should do better than one that invests in large public companies. Besides, it'd be a cool financial hack.

parker 19y ago

>> I suspect that if a VC tried a new model (focusing on sustainable growth and revenue/profit), they'd find that they'd have a healthier portfolio that was largely illiquid. Well, if VCs were to concentrate on sustainable growth and profits, maybe we'd see a resurgence of the flacid IPO market. It wasn't too long ago that tech entrepreneurs were motivated to make profits which then allowed them to take their companies public. Seqouia would not have made a crazy-multiple on their investment if Google had focused on being bought pre-revenue in preference over creating profits and taking themselves public. Google's IPO absolutely dwarfs YouTube's acquisition. I think a VC model encouraging profits over growth would be a healthy thing for everyone!

nostrademons 19y ago

Something I'm curious about: what if VCs worked like Berkshire Hathaway, reinvesting the cash thrown off by portfolio businesses but never selling their shares? Profitable businesses all generate return-on-capital; that cash can be reinvested to get new businesses off the ground. It seems like this would be a good model for seed-funding businesses like YC to try, because they've got many more at-bats than big VCs. It might be hard for a big VC firm to generate enough cash for this: if the average investment is $5M, they take 50% of the company, and 90% of their investments fail, then their "hit" needs to churn off $100M in profits to sustain the next round of startups. But if you target hundreds of niche businesses, your investment is $20K, you take 10% of the company, and 50% of the companies survive, then they only need to spin off $400K/year in profits to fund the next round. That seems a lot more achievable. Then again, one of the reasons Berkshire is successful is that Buffett refuses to invest in businesses that don't have predictable streams of cashflow. Startups are anything but predictable, so maybe the model's fundamentally flawed when it comes to startups.

webwright 19y ago
"Something I'm curious about: what if VCs worked like Berkshire Hathaway, reinvesting the cash thrown off by portfolio businesses but never selling their shares?" How does cash get thrown off? Are you suggesting a "dividends off of profits" type of thing for growth companies? Aren't growth companies supposed to be reinvesting profits in their own growth? The problem with dividends is that they are really only good one the initial investment is liquid. So if Berkshire invests in a value company that throws off 3% dividends per quarter, that's great. But it's only great because they can get their cash out at any time. If a VC invests in a startup (say $1mm), how exciting is the prospect of 50% chance of failure, but a possible 3% quarterly dividend IF the company succeeds? With no actual market to sell their initial investment of $1mm? I can't make these numbers look attractive in my head.
- nostrademons 19y ago
  "Are you suggesting a "dividends off of profits" type of thing for growth companies? Aren't growth companies supposed to be reinvesting profits in their own growth?" Yeah, dividends-off-profits. The growth-company thing is an issue for the initial ramp-up phase: it'd probably be 10 years or so before the fund would start having additional capital to invest. But in the steady-state, older non-growing businesses throw off cash that can be reinvested in small growth businesses. "So if Berkshire invests in a value company that throws off 3% dividends per quarter, that's great. But it's only great because they can get their cash out at any time." Berkshire can't cash out of their value companies at any time. Their typical modus operandi is to buy 80% of a successful privately-held business, leaving the other 20% to the founders. The companies remain privately held, and their stock is not sold on the open market. The only way Berkshire can cash out is if they find another buyer, like a private equity firm or large conglomerate, to take the whole business off their hands at once. Also, dividends thrown off by private companies are often a lot more than 3% (public companies have such lousy dividends largely because shareholders lack bargaining power). Take See's Candy, one of Berkshire's early acquisitions (http://valueinvestingresource.blogspot.com/2008/03/sees-candy-magic-formula-stock-from.html http://valueinvestingresource.blogspot.com/2008/03/sees-cand...). They bought it in 1972 for $25M on earnings of $5M. Since then, See's has required capital infusions of $32M and spun off dividends of $1.35B. That's a dividend-to-profit ratio of 98%, in comparison to the normal Wall Street averages of 30-50%. Of course, few startup entrepreneurs would be willing to sell 80% of the company from the outset. Berkshire functions in reverse to VC firms, providing liquidity and multi-million-$ payouts to firms that have already gotten successful. But what if you reversed the terms? 10-20% of the equity for the chance to be your own boss? With the investor's dividend payouts protected by a legal clause in the investment documents, guaranteeing that after certain profitability and cash reserve milestones are met and growth has fallen below a certain amount, X% of the profits are distributed as dividends? This is all idle speculation, since I don't have money to put where my mouth is. But if I had a billion dollars or so, I'd definitely want to try it. Because if these assumptions are true: 1.) Startups are the most productive part of the economy 2.) A small initial investment would let many more people quit their day jobs and found startups 3.) Getting bought destroys most of the efficiency advantages of being a startup Then a logical consequence is that a firm that buys-and-holds small profit-oriented startups should do better than one that invests in large public companies. Besides, it'd be a cool financial hack.