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Tyler, I've been very interested in this development and I have a somewhat fundamental question to you. I've seen a number of VCs and other pundits recently sa

Tyler, I've been very interested in this development and I have a somewhat fundamental question to you. I've seen a number of VCs and other pundits recently say things of the form "there's a reason why for decades, there were only bank loans and VC and not much in-between". Eg Jerry Neumann (a NY based solo investor) has a nice twitter rant about it here: https://twitter.com/ganeumann/status/1093961051425697794 https://twitter.com/ganeumann/status/1093961051425697794 If I follow the math in his linked blog posts well (eg [0]), he's basically putting down the hypothesis that there's 3 categories of companies (determined by the alpha value of the power-law distribution they're in): 1. Companies where the risk and the upside potential are small. This is where bank loans are focused. 2. Companies where the risk is enormous but the upside potential is "meh". 3. Companies where the risk is enormous but the upside potential is also enormous. This is where VC is focused, and it's why they're all about finding those few big hits because this covers all the losses (or mediocre performance) of the rest. Neumann appears pretty confident about this hypothesis; not because he can explain the underlying phenomenon, but simply because until now he's not seen much successful funding for companies that's neither VC nor bank loans. And if his hypothesis is right, then you're targeting companies of type 2: investments with enormous risk (comparable to that of a high-growth startup) but at the same time you're hard-capping your upside at 5x. That seems madness. I don't think you're mad, however, so you must believe that his hypothesis is wrong. If so, why now? What changed in the world, or in the investment landscape, or in technology, that suddenly multiple people (you, indie.vc, etc etc) believe that a low-capped profit sharing scheme for startup investments is a good idea, when nobody did before? Did the risk go down? How did it? Why? Why now and not 10 years ago? Super interested in any insights you might have on this. Great job, hope you succeed (i.e. I hope to be proven wrong) [0] http://reactionwheel.net/2019/01/why-do-vcs-insist-on-only-investing-in-high-risk-high-return-companies.html http://reactionwheel.net/2019/01/why-do-vcs-insist-on-only-i... * disclaimer: I'm a founder, not an investor and I don't spend a lot of time thinking about this stuff. Ergo I probably misinterpreted a lot of what Neumann is saying. If someone (or Jerry himself) reads this and thinks they know better, I'll be happy to stand corrected.

SatvikBeri 8y ago
I've worked at a lender that did loans to small businesses somewhere in between categories 1 and 2. The major thing that's changed is the availability of data. A $100k loan used to take several hours of expensive analyst time to process manually, and since most would be rejected, it wouldn't be worth it. Now a business can, e.g., securely share real bank account data. That makes the whole process much faster, which reduces the cost per loan, which makes smaller loans profitable. I imagine something similar can apply for small business equity.
j_shi 8y ago
Defer to OP but that feels like bit lazy apologist framework for status quo. A few (unsubstantiated) guesses at reasons to counter: 1 - Medium risk medium reward opportunities exist (a currently unprofitable but otherwise promising startup addressing a 25m niche can't get bank debt or venture funding) 2 - Could decrease risk holding reward (avg. multiple of investment) constant by having small funds with managers that have deep knowledge of particular niche deploy smaller checks in markets they are better at evaluating (v. large fund managers needing to cast net wider than their "lane") 3 - Size expectation can be correlated with risk. Can decrease risk holding reward (avg multiple of investment) constant by just having smaller funds writing smaller checks for smaller companies that be happy with smaller exits or alt. upside capture (v. forcing companies that could work with small exits into chasing big inflexible exits). Sure no 100x-ers but theoretically could see higher blended fund returns 4 - Opportunities generally continuous on risk and reward calling for equally diverse approaches to capitalization
- wdewind 8y ago
  > 1 - Medium risk medium reward opportunities exist (a currently unprofitable but otherwise promising startup addressing a 25m niche can't get bank debt or venture funding) I think one of the main arguments in favor of a bimodal distribution of VC and Bank (or high and low risk) funding is that if you are in that middle "medium risk medium reward" zone it can be really difficult to defend your position for any stretch of time. You will be attacked from both bigger players to whom you've proven a market, and smaller players who are willing to take bigger risks to see if they can blow that market up (or bite off a smaller piece of it). In order to maintain a medium risk medium reward business you need something approaching a monopoly, but also you need the market in which you have a monopoly to be growing and not attracting new players. Maybe some of these exist, but they are very rare and I suspect identifying them is not significantly easier than identifying startups with high growth potential. So I think skrebbel's question is pretty fair, though I suspect OP has heard it a lot. I would predict that this fund passes on WAY more deals than even a standard VC fund, and will be required to determine the risk of the investment even more effectively. That's a tough problem, and I do really wish them luck!

SatvikBeri 8y ago

I've worked at a lender that did loans to small businesses somewhere in between categories 1 and 2. The major thing that's changed is the availability of data. A $100k loan used to take several hours of expensive analyst time to process manually, and since most would be rejected, it wouldn't be worth it. Now a business can, e.g., securely share real bank account data. That makes the whole process much faster, which reduces the cost per loan, which makes smaller loans profitable. I imagine something similar can apply for small business equity.

j_shi 8y ago

Defer to OP but that feels like bit lazy apologist framework for status quo. A few (unsubstantiated) guesses at reasons to counter: 1 - Medium risk medium reward opportunities exist (a currently unprofitable but otherwise promising startup addressing a 25m niche can't get bank debt or venture funding) 2 - Could decrease risk holding reward (avg. multiple of investment) constant by having small funds with managers that have deep knowledge of particular niche deploy smaller checks in markets they are better at evaluating (v. large fund managers needing to cast net wider than their "lane") 3 - Size expectation can be correlated with risk. Can decrease risk holding reward (avg multiple of investment) constant by just having smaller funds writing smaller checks for smaller companies that be happy with smaller exits or alt. upside capture (v. forcing companies that could work with small exits into chasing big inflexible exits). Sure no 100x-ers but theoretically could see higher blended fund returns 4 - Opportunities generally continuous on risk and reward calling for equally diverse approaches to capitalization

wdewind 8y ago
> 1 - Medium risk medium reward opportunities exist (a currently unprofitable but otherwise promising startup addressing a 25m niche can't get bank debt or venture funding) I think one of the main arguments in favor of a bimodal distribution of VC and Bank (or high and low risk) funding is that if you are in that middle "medium risk medium reward" zone it can be really difficult to defend your position for any stretch of time. You will be attacked from both bigger players to whom you've proven a market, and smaller players who are willing to take bigger risks to see if they can blow that market up (or bite off a smaller piece of it). In order to maintain a medium risk medium reward business you need something approaching a monopoly, but also you need the market in which you have a monopoly to be growing and not attracting new players. Maybe some of these exist, but they are very rare and I suspect identifying them is not significantly easier than identifying startups with high growth potential. So I think skrebbel's question is pretty fair, though I suspect OP has heard it a lot. I would predict that this fund passes on WAY more deals than even a standard VC fund, and will be required to determine the risk of the investment even more effectively. That's a tough problem, and I do really wish them luck!