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Why would bond rates make or break A16Z? A lower interest rate on bonds may mean LPs allocate more money to VC funds, but the bulk of A16Z’s fund is surely not

by alxmng 4y ago

Why would bond rates make or break A16Z? A lower interest rate on bonds may mean LPs allocate more money to VC funds, but the bulk of A16Z’s fund is surely not people who will all pull out their money and put it into bonds if rates go up a bit. Correct me if I’m wrong, but the only affect a rise in rates could have is to reduce the amount of funds raised going forward? Is that even significant for VC funds?

ak_111 4y ago
you need to think 2nd order effects: VCs need mega exits to make returns, which usually are blockbuster IPOs. Higher rates will crash quite a lot of high-growth stocks making IPOs less appealing for investors, which messes up with A16z business model of exiting via IPOs.
- antupis 4y ago
  They can also get fabulous deals currently so it is not bleak as it sounds. Also both Andreessen and Horowitz have that cockroach like ability to survive so I would not count them out even whole business model would collapse overnight.
jxf 4y ago
VC returns are fiercely skewed: a long tail of stuff that's effectively negative to zero returns and a tiny minority of stuff that does really well. How does it do really well? By having a very profitable in-demand public IPO. How do you get macroeconomically favorable in-demand IPOs? Lots of capital looking for alternative returns. What creates willingness to consider alternative returns? Among other things, reductions in the risk-free return rate obtained by bonds. High bond rates reduce the demand for alternative returns, which reduces the demand for IPO participation, which in turn affects VC returns.
- alxmng 4y ago
  Sure, maybe the IPO shares sell for lower with higher rates, which may mean a lower total return for the VC. But to what degree? So the VC get $9 billion instead of $10. It seems to me the only thing that would affect is future fund allocation.
  - JumpCrisscross 4y ago
    > the VC get $9 billion instead of $10 Andreessen has been raising massive funds (because they can since investors were flush due to low interest rates) which need to write large cheques. They aren’t doing traditional venture capital as much as late-stage growth equity. Since no quality company will sell half of itself to Andreessen, this almost necessitates writing a big cheque into a multibillion-dollar round at $30bn valuations, or medium-sized cheques into terrible ones. The former go public at $10bn, the latter go bust.
    - alxmng 4y ago
      Right, but if interest rates are high they can still go public at a large valuation...
      - JumpCrisscross 4y ago
        > if interest rates are high they can still go public at a large valuation Not as large as previously. And critically, smaller than where they invested. Going public at $10bn when you bought for $30bn isn’t a good deal.
  - jxf 4y ago
    You missed the "fiercely skewed" part. The VCs have to be participating to begin with. Even one of these deals can make or break a portfolio, so they have to cast a wide net -- but the capital reserve is drier now. This disproportionately (and negatively) impacts VC returns -- it's not the difference between $10 billion and $9 billion, it's the difference between $10 billion and $100 million. Additionally, higher risk-free rates of return mean that investors demand results _today_. If the risk-free rate is ~0%, the market is content to wait; capital today is about as valuable as capital ten years from now. But if it's, say, 6%, then investors need bigger returns and sooner from your VC funds to beat the market at large. But the cost of building the company hasn't changed, so this makes VCs have a harder time.
    - alxmng 4y ago
cameldrv 4y ago
VCs invest in companies that typically won’t make big profits for 10 years or so. At zero rates, the market doesn’t care if it gets its money today or in ten years. At 5%, the 10 year money is worth 60 cents. That means all of those hypothetical companies are worth 40% less, but it still costs about the same to build them.
- alxmng 4y ago
  > That means all of those hypothetical companies are worth 40% less, but it still costs about the same to build them. I don't follow. The gains are realized when the company is acquired or goes public. If bond yields are 0%, the VC invests $9 and gets $10 after 10 years, the returns are $1. If bond yields are 5%, the VC returns are still $1. If they had instead invested in bonds, their return would have been $0.45. Even if bonds yield better returns, that doesn't change the VC's returns.
  - abm53 4y ago
    The difference is that the bond return is (to first order) riskless and risk has a cost. What is the variance on the VC return (and is $9 a realistic mean of the distribution to begin with?).
    - alxmng 4y ago
      Right, but that doesn't change the return. It would only change the amount of money being invested in VC or IPOs versus bonds. And the total money chasing stocks isn't evenly distributed amongst stocks, so less money in the stock market doesn't necessarily mean a lower valuation for a particular company (such as the big winner in a VC portfolio). The risk free return is an opportunity cost. If I invest $10 and get back $11, the net is $1 regardless of whether bonds yielded 0% or 100%.
      - abm53 4y ago
        And that cost is taken into account when people value the merits of a particular investment/company. If bonds yield 100% p/a then an investment with even a decent potential payout in 10 years time will be seen as worthless. But one that is likely to pay out a dividend tomorrow may not be. That’s the whole premise behind discounted cashflow analysis: mechanistically taking into account the opportunity cost of the risk-free interest rate to derive a valuation.

by alxmng 4y ago

ak_111 4y ago

you need to think 2nd order effects: VCs need mega exits to make returns, which usually are blockbuster IPOs. Higher rates will crash quite a lot of high-growth stocks making IPOs less appealing for investors, which messes up with A16z business model of exiting via IPOs.

antupis 4y ago
They can also get fabulous deals currently so it is not bleak as it sounds. Also both Andreessen and Horowitz have that cockroach like ability to survive so I would not count them out even whole business model would collapse overnight.

jxf 4y ago

VC returns are fiercely skewed: a long tail of stuff that's effectively negative to zero returns and a tiny minority of stuff that does really well. How does it do really well? By having a very profitable in-demand public IPO. How do you get macroeconomically favorable in-demand IPOs? Lots of capital looking for alternative returns. What creates willingness to consider alternative returns? Among other things, reductions in the risk-free return rate obtained by bonds. High bond rates reduce the demand for alternative returns, which reduces the demand for IPO participation, which in turn affects VC returns.

alxmng 4y ago
Sure, maybe the IPO shares sell for lower with higher rates, which may mean a lower total return for the VC. But to what degree? So the VC get $9 billion instead of $10. It seems to me the only thing that would affect is future fund allocation.
- JumpCrisscross 4y ago
  > the VC get $9 billion instead of $10 Andreessen has been raising massive funds (because they can since investors were flush due to low interest rates) which need to write large cheques. They aren’t doing traditional venture capital as much as late-stage growth equity. Since no quality company will sell half of itself to Andreessen, this almost necessitates writing a big cheque into a multibillion-dollar round at $30bn valuations, or medium-sized cheques into terrible ones. The former go public at $10bn, the latter go bust.
  - alxmng 4y ago
    Right, but if interest rates are high they can still go public at a large valuation...
    - JumpCrisscross 4y ago
      > if interest rates are high they can still go public at a large valuation Not as large as previously. And critically, smaller than where they invested. Going public at $10bn when you bought for $30bn isn’t a good deal.
- jxf 4y ago
  You missed the "fiercely skewed" part. The VCs have to be participating to begin with. Even one of these deals can make or break a portfolio, so they have to cast a wide net -- but the capital reserve is drier now. This disproportionately (and negatively) impacts VC returns -- it's not the difference between $10 billion and $9 billion, it's the difference between $10 billion and $100 million. Additionally, higher risk-free rates of return mean that investors demand results _today_. If the risk-free rate is ~0%, the market is content to wait; capital today is about as valuable as capital ten years from now. But if it's, say, 6%, then investors need bigger returns and sooner from your VC funds to beat the market at large. But the cost of building the company hasn't changed, so this makes VCs have a harder time.
  - alxmng 4y ago

cameldrv 4y ago

VCs invest in companies that typically won’t make big profits for 10 years or so. At zero rates, the market doesn’t care if it gets its money today or in ten years. At 5%, the 10 year money is worth 60 cents. That means all of those hypothetical companies are worth 40% less, but it still costs about the same to build them.

alxmng 4y ago
> That means all of those hypothetical companies are worth 40% less, but it still costs about the same to build them. I don't follow. The gains are realized when the company is acquired or goes public. If bond yields are 0%, the VC invests $9 and gets $10 after 10 years, the returns are $1. If bond yields are 5%, the VC returns are still $1. If they had instead invested in bonds, their return would have been $0.45. Even if bonds yield better returns, that doesn't change the VC's returns.
- abm53 4y ago
  The difference is that the bond return is (to first order) riskless and risk has a cost. What is the variance on the VC return (and is $9 a realistic mean of the distribution to begin with?).
  - alxmng 4y ago
    Right, but that doesn't change the return. It would only change the amount of money being invested in VC or IPOs versus bonds. And the total money chasing stocks isn't evenly distributed amongst stocks, so less money in the stock market doesn't necessarily mean a lower valuation for a particular company (such as the big winner in a VC portfolio). The risk free return is an opportunity cost. If I invest $10 and get back $11, the net is $1 regardless of whether bonds yielded 0% or 100%.
    - abm53 4y ago
      And that cost is taken into account when people value the merits of a particular investment/company. If bonds yield 100% p/a then an investment with even a decent potential payout in 10 years time will be seen as worthless. But one that is likely to pay out a dividend tomorrow may not be. That’s the whole premise behind discounted cashflow analysis: mechanistically taking into account the opportunity cost of the risk-free interest rate to derive a valuation.