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One thing that you have to keep in mind is that the 20% part is effectively a European call option on the fund's portfolio, with strike equal to the fund's init

One thing that you have to keep in mind is that the 20% part is effectively a European call option on the fund's portfolio, with strike equal to the fund's initial value (so ATM - At The Money - when the fund starts) and notional amount of 20% of the fund's value. The manager gets that option for free, in fact he's paid 2% a year to hold that long option (and do his/hers job). Call options are more valuable if the underlying security is more volatile (because there's higher chance of ending in the money), which of course encourages high risk taking. This is all not necessarily bad, but the incentives are not to be ignored. VCs have absolutely zero interest in stable businesses (remember - they want the volatility). If you're a stable business you would want a value investor who keeps close to 100% of his net worth in his fund, like Warren Buffet or Seth Klarman to give two famous names.

woah 7y ago
It’s strange how often people need to be reminded on here that VCs invest in businesses that grow fast or fail. There’s a vocal contingent on here that feel it’s some kind of moral failing and are mad that nobody is getting excited about their bingo card creating website.
- csa 7y ago
  > There’s a vocal contingent on here that feel it’s some kind of moral failing and are mad that nobody is getting excited about their bingo card creating website. LOL. I hope this is HN /s. If so, it has several layers of humor. The guy who actually created a bingo card creation site has been fairly vocal with his stance that VC money should only be taken for rocket-ship trajectory businesses — with bingo card creation and other businesses he ran not being of that ilk. IIRC, people have tried to get him on the VC track with a different business to no avail (yet). Additionally, he (informally?) advises people who are applying to YC, and I think one point he consistently brings up with founders is whether they are sure that their business even wants to go on the VC path/trajectory. I think that’s a great question that many people don’t stop to ask due to the pejorative “lifestyle business” label (cough that might have a high chance of increasing ones net worth by millions rather than billions cough). Regardless, to confirm and reiterate your point, VCs aren’t looking for singles... their looking for home runs, and they don’t mind striking out while pursuing that goal. If you take VC money, fully expect to be pushed to those extremes.
  - hef19898 7y ago
    Funding a company is hard. I'm bootstrapping and funding will become a key issue in the next couple of months. My preferred solution is a classical bank loan, maybe backed up by some of the available government-sponsored programs. Why? Because while I maybe could frame my business in some VC-friendly way and go out pitching it I don't want to give up more control than absolutely necessary. Also, I am perfectly fine to have a well running mid-sized business one day (if luck will have it). VCs are not, and being forced to go for 20x+ exit can only mean one huge acquisition or an IPO. Not my cup of tea. Also, every minute I pitch a VC is minute I cannot pitch actually paying customers. I get that some businesses need a lot of money to come up with a product and thus need VCs. I'm lucky to not need that amount of money and to finance the whole product development myself for the next couple of months. But I can't stop wondering if it would be possible for VCs to buolzd a portfolio of profitable, cash positive mid-sized businesses to find the more adventurous investments.
    - csa 7y ago
      Assuming that this is a business that has some sort of online component (esp. payments), consider Stripe — they offer loans based on cash flow history with their service. I’m not sure what level of cash you need, but this might do the trick without giving up equity or control. Not affiliated with stripe — just a fan.
      - hef19898 7y ago
        Thanks for the tip, certainly will take a look, could be very helpful in case I sell stuff myself. Which also needs a lot more capital. Does stripe also have a B2B / invoicing functionality?
        clintonb 7y ago
        Yes. Stripe Billing (https://stripe.com/billing https://stripe.com/billing) supports recurring invoicing (e.g. subscriptions) and non-recurring invoices.
- paulddraper 7y ago
  VCs sell rocket fuel. If you're building a rocket, buy some rocket fuel. Otherwise, go to the gas station/bank.
- nickpinkston 7y ago
  Yea, I mean I get why a lot of people would be angry that their very real, but not VC fundable, business is hard to finance. There's a lot of things that should exist that have small markets, long time horizons, lots of upfront risk, are in markets that VC's don't understand, etc. The shame is that for many of these there are likely possible funding sources that could exist, but new asset classes are hard to get started, especially when LPs are pretty risk averse and experience strong herd mentality effects.
- nicoburns 7y ago
  I think it's a failing of our economic system that wealth is concentrated enough for VC's to exist in the first place. It would be better if such investment power was distributed.
- soapboxrocket 7y ago
  The problem as I see it is that Bingo just isn't a dynamic game, you have a static card with single numbers called out. My bingo card app is unique in that fact that your card changes in direct relation to the number of possible win paths you have at any given moment.
- robbiemitchell 7y ago
  Yes! VC is an asset class targeting high-growth, high-risk opportunities. As an LP (e.g., pension fund, college endowment, individual baller), you put some % of your money in VC funds as part of a broad portfolio of investment types. If you want to grow a stable business and share portions of your revenue, there are other sources of investment such as Private Equity and plain-old debt (loans).
camjw 7y ago
Call options are more valuable if the underlying security is more volatile (because there's higher chance of ending in the money) Whatever the volatility is you still (in Black-Scholes) have a 50/50 of the option ending ITM (stock returns are normally distributed, higher volatility just means higher std. deviation). One reason why ATM options are more valuable with higher volatility is because there's a greater chance of the option ending far away from the strike price (either in the positive OR negative direction), so there's a lot of time value on those. This doesn't discount the rest of your post though, clear that VCs go for high risk options.
- H8crilA 7y ago
  Oh yes, you're completely right. I oversimplified :) And, to nitpick back: the logarithm of stock return is normally distributed under B-S.
  - camjw 7y ago
    Sorry to be that guy again but B-S assumes stock prices are log-normally distributed but stock returns are normally distributed :) [0] [0] https://www.investopedia.com/terms/b/blackscholes.asp https://www.investopedia.com/terms/b/blackscholes.asp
    - H8crilA 7y ago
      It's all fine :). I thought that "stock return" is the [exit price]/[entry price], for an asset that does not pay dividends, no? exit/entry still requires a log() to be normally distributed, for example exit/entry is non-negative, wile gaussian is of course sometimes negative, no matter what the mean is.
      - camjw 7y ago
        I think your formula is slightly off. Stock return = (exit_price - entry_price + dividends) / entry_price. It’s clear that then the mean return is the dividends paid and can be negative if the exit price is sufficiently low. I think by a bit of squinting (using the central limit theorem) you can say that this should be normally distributed as long as entry_price and exit_price have the same distribution
smabie 7y ago
Good insight, but the incentives don’t exactly match up to how you describe. Their investments actually looks like an American option instead of a Euro option because they can flip their investments when in the black. Since it’s not possible to cash out Euro options in this way, their incentives and compensation look much more like American options than Euro ones.
- H8crilA 7y ago
  Yeah, realistically it's something like a call option, not exactly European or American. The details depend on how precisely is the fund structured. Most importantly - when exactly the fund managers are allowed to cash-out their 20% of wins (at the end of life of the fund? perhaps the fund is in principle perpetual? perhaps whenever there's a successful "exit" of one of the investments? perhaps every year if it's in the green?).

woah 7y ago

It’s strange how often people need to be reminded on here that VCs invest in businesses that grow fast or fail. There’s a vocal contingent on here that feel it’s some kind of moral failing and are mad that nobody is getting excited about their bingo card creating website.

csa 7y ago
> There’s a vocal contingent on here that feel it’s some kind of moral failing and are mad that nobody is getting excited about their bingo card creating website. LOL. I hope this is HN /s. If so, it has several layers of humor. The guy who actually created a bingo card creation site has been fairly vocal with his stance that VC money should only be taken for rocket-ship trajectory businesses — with bingo card creation and other businesses he ran not being of that ilk. IIRC, people have tried to get him on the VC track with a different business to no avail (yet). Additionally, he (informally?) advises people who are applying to YC, and I think one point he consistently brings up with founders is whether they are sure that their business even wants to go on the VC path/trajectory. I think that’s a great question that many people don’t stop to ask due to the pejorative “lifestyle business” label (cough that might have a high chance of increasing ones net worth by millions rather than billions cough). Regardless, to confirm and reiterate your point, VCs aren’t looking for singles... their looking for home runs, and they don’t mind striking out while pursuing that goal. If you take VC money, fully expect to be pushed to those extremes.
- hef19898 7y ago
  Funding a company is hard. I'm bootstrapping and funding will become a key issue in the next couple of months. My preferred solution is a classical bank loan, maybe backed up by some of the available government-sponsored programs. Why? Because while I maybe could frame my business in some VC-friendly way and go out pitching it I don't want to give up more control than absolutely necessary. Also, I am perfectly fine to have a well running mid-sized business one day (if luck will have it). VCs are not, and being forced to go for 20x+ exit can only mean one huge acquisition or an IPO. Not my cup of tea. Also, every minute I pitch a VC is minute I cannot pitch actually paying customers. I get that some businesses need a lot of money to come up with a product and thus need VCs. I'm lucky to not need that amount of money and to finance the whole product development myself for the next couple of months. But I can't stop wondering if it would be possible for VCs to buolzd a portfolio of profitable, cash positive mid-sized businesses to find the more adventurous investments.
  - csa 7y ago
    Assuming that this is a business that has some sort of online component (esp. payments), consider Stripe — they offer loans based on cash flow history with their service. I’m not sure what level of cash you need, but this might do the trick without giving up equity or control. Not affiliated with stripe — just a fan.
    - hef19898 7y ago
      Thanks for the tip, certainly will take a look, could be very helpful in case I sell stuff myself. Which also needs a lot more capital. Does stripe also have a B2B / invoicing functionality?
      - clintonb 7y ago
        Yes. Stripe Billing (https://stripe.com/billing https://stripe.com/billing) supports recurring invoicing (e.g. subscriptions) and non-recurring invoices.
paulddraper 7y ago
VCs sell rocket fuel. If you're building a rocket, buy some rocket fuel. Otherwise, go to the gas station/bank.
nickpinkston 7y ago
Yea, I mean I get why a lot of people would be angry that their very real, but not VC fundable, business is hard to finance. There's a lot of things that should exist that have small markets, long time horizons, lots of upfront risk, are in markets that VC's don't understand, etc. The shame is that for many of these there are likely possible funding sources that could exist, but new asset classes are hard to get started, especially when LPs are pretty risk averse and experience strong herd mentality effects.
nicoburns 7y ago
I think it's a failing of our economic system that wealth is concentrated enough for VC's to exist in the first place. It would be better if such investment power was distributed.
soapboxrocket 7y ago
The problem as I see it is that Bingo just isn't a dynamic game, you have a static card with single numbers called out. My bingo card app is unique in that fact that your card changes in direct relation to the number of possible win paths you have at any given moment.
robbiemitchell 7y ago
Yes! VC is an asset class targeting high-growth, high-risk opportunities. As an LP (e.g., pension fund, college endowment, individual baller), you put some % of your money in VC funds as part of a broad portfolio of investment types. If you want to grow a stable business and share portions of your revenue, there are other sources of investment such as Private Equity and plain-old debt (loans).

camjw 7y ago

Call options are more valuable if the underlying security is more volatile (because there's higher chance of ending in the money) Whatever the volatility is you still (in Black-Scholes) have a 50/50 of the option ending ITM (stock returns are normally distributed, higher volatility just means higher std. deviation). One reason why ATM options are more valuable with higher volatility is because there's a greater chance of the option ending far away from the strike price (either in the positive OR negative direction), so there's a lot of time value on those. This doesn't discount the rest of your post though, clear that VCs go for high risk options.

H8crilA 7y ago
Oh yes, you're completely right. I oversimplified :) And, to nitpick back: the logarithm of stock return is normally distributed under B-S.
- camjw 7y ago
  Sorry to be that guy again but B-S assumes stock prices are log-normally distributed but stock returns are normally distributed :) [0] [0] https://www.investopedia.com/terms/b/blackscholes.asp https://www.investopedia.com/terms/b/blackscholes.asp
  - H8crilA 7y ago
    It's all fine :). I thought that "stock return" is the [exit price]/[entry price], for an asset that does not pay dividends, no? exit/entry still requires a log() to be normally distributed, for example exit/entry is non-negative, wile gaussian is of course sometimes negative, no matter what the mean is.
    - camjw 7y ago
      I think your formula is slightly off. Stock return = (exit_price - entry_price + dividends) / entry_price. It’s clear that then the mean return is the dividends paid and can be negative if the exit price is sufficiently low. I think by a bit of squinting (using the central limit theorem) you can say that this should be normally distributed as long as entry_price and exit_price have the same distribution

smabie 7y ago

Good insight, but the incentives don’t exactly match up to how you describe. Their investments actually looks like an American option instead of a Euro option because they can flip their investments when in the black. Since it’s not possible to cash out Euro options in this way, their incentives and compensation look much more like American options than Euro ones.

H8crilA 7y ago
Yeah, realistically it's something like a call option, not exactly European or American. The details depend on how precisely is the fund structured. Most importantly - when exactly the fund managers are allowed to cash-out their 20% of wins (at the end of life of the fund? perhaps the fund is in principle perpetual? perhaps whenever there's a successful "exit" of one of the investments? perhaps every year if it's in the green?).