4 ms·

VC firms face new scrutiny from LPs

42 points by ilamont 3y ago

fidotron 3y ago
Even the most cynical of us were amazed by the fundamental lack of due diligence shown with FTX. If the people that funded that were asking you for more money then responding with scrutiny is at the polite end of possible responses. The problem VCs have is that the signal that a company is VC funded is now only a sign that the founders are connected. It says nothing about competence or ability to execute at all.
- gunapologist99 3y ago
  Do you think that VC's should be pulling credit reports or criminal background checks or something, like a bank? (And what would that have accomplished with SBF anyway?) Lots of founders don't have good credit, or maybe even any credit at all. Do we really want to make it even harder to raise? There is no "due diligence" that can detect when you've invested in a turkey, or even a turkey that later turns out to have combined funds (perhaps fraudulently) or practiced financial mismanagement to the point that he was bailing out Alameda with FTX funds. That's why you invest in a wide variety of things. FTX is why LPs might be hesitant to invest in Sequoia in the future, but the "variety" part might also be why they don't hesitate, too.
  - blitzar 3y ago
    SBF presented himself as a shit talking bullshitter dosed up to the eyeballs on amphetamines. Not only did Sequoia notice that this was the case, but they loved it and threw as many fistfulls of cash as they could at it.
    - gunapologist99 3y ago
      Point taken, but he also presented himself as a brilliant (if slightly psychotic) nerd, which is exactly the archetype that has worked well for Sequoia in the past.
  - AlexandrB 3y ago
    > Do you think that VC's should be pulling credit reports or criminal background checks or something, like a bank? It's funny to use this as some kind of absurd example when in many places this kind of stuff is standard before someone lets you rent an apartment. Isn't vetting founders and their companies before risking the LP's money part of the job for a VC?
    - gunapologist99 3y ago
      Of course, it is an absurd example. I'm sure SBF had great credit and no criminal background. Very few founders who would ever catch even the remotest VC interest would have any significant negatives, on paper anyway. SBF was seen as a catch because of his elitist and entrepreneurial background, with two professor parents at Stanford, a background on Wall Street, a hilariously affected backstory about international cryptocurrency arbitrage, crazy ideas on how his future wealth could (and would) save the world, and a later history of donating or bundling crazy amounts of money for his preferred political party (and anyone else in either party or agency that he could perhaps influence with donations). That's why checking credit report or even criminal background is so absurd in this context. Checks like this won't do anything except further entrench the elitist anti-meritocracy that currently infects the VC community. Lots of people can walk into a bank and get a loan, but very few can walk into Sand Hill Road and raise a round of any size.
- malux85 3y ago
  Yep, one of the recent places I have worked had a 19 year old founder and raised 6 million euros. Founder has no experience, a buggy non functioning mvp, no customers, no traction. He only got investment by plagiarising a paper that got cited a few times and then exploiting the fact that he fooled one clueless VC into giving them money so he must be good. This snowballed into other investors giving money. No technical DD, I spent 20 minutes reading the code when I started and could tell it was a whole bunch of nothing - a tiny system that creates a docker container but worse (reinventing the square wheel) Well he might have potential you say? Nope. It’s been 2 years and he has completely failed to execute and get even a minimal number of customers (I.E. the individual ones that try it immediately churn because it’s buggy and useless) It’s a complete circus, I can’t believe that a group of well known VC names are so clueless
a-posteriori 3y ago
Whenever I see articles like this I come back to Calpers venture returns over the last 20 years: > Calpers' venture returns have been historically lackluster. From 2000 to 2020, its venture performance was a dismal 0.49%, compared to 11.59% in buyouts. Calpers declined to comment. https://pitchbook.com/news/articles/calpers-venture-asset-class-tiger-lightspeed https://pitchbook.com/news/articles/calpers-venture-asset-cl... How LPs didn't take a step back and ask, "does this strategy work?". I don't know.
- hef19898 3y ago
  Hoping either for an IPO, SPAC or SoftBank? After all, people bet on horses, sports, play the lottery...
  - Given_47 3y ago
    Sports is easy enough. The hardest part is getting around limits and finding new accounts cuz anyone with a brain inevitably gets kicked. But overall relatively easy side income
- gumby 3y ago
  When Calpers started reporting this info their portfolio companies (VCs like Sequoia) were furious and tried to block it. It exposed their made up IRR numbers to public view. But as a public agency, Calpers was able to stick to its guns and provide a valuable service. People forget how tiny the VC business is: just a pimple on the PE market. Typically it’s a tiny part of a big investor’s portfolio, just to have some exposure diversity. You can tell how important it is to them when you attend an LP meeting for a VC fund: the GPs may be bowing and scraping* but among the LPs’ representatives are a lot of 22 year old first year associates, which shows how unimportant the sector is to these big guys. * props to the GPs who are both not arrogant and not ingratiating to their customers (cough sorry, “LPs”). In my experience there are fewer than you would think.
  - a-posteriori 3y ago
    Well put and I have also witnessed the same patterns at GP/LP meetings. Ironically, Calpers' excuse for their poor returns is that the "top tier" VCs (such as Sequoia) now exclude them due to their public reporting requirements, and therefore they are forced to deploy to tier 2 managers.
snisarenko 3y ago
I think we would see less poor VC investments if there was a practical way to short or bet against these investments. Currently the only punishment a bad VC gets, is that they still collect their fees, and get the wag of the finger from the rich people who gave them money.
- dpflan 3y ago
  So a derivatives market for betting an investment's success? Would that be effectively, a market for the (private) investment's stock?
  - snisarenko 3y ago
    Yeah, I guess something like that. Other approach is for LPs to reject any percentage based management fees. I think a skin in the game payout structure for VCs would be better. - VC has to commit x% (5%)? of their net worth into the fund - VC gets bonus payouts only on individual investments that are net profitable (something like 3% of the net profit from the invested LP money) - Could also be augmented with a Flat Yearly Salary/Fee to cover basic operations (not a percentage based fee) If I was an LP thats how I would do it. No way would I agree to a flat percentage mangement fee.
    - smartbettor 3y ago
      I'm not sure if you know but all of this has been tried or is currently how it works. To begin with, most GP's have north of 5% of their net worth in the Funds or they're leveraged and borrowing against their homes etc. Partners usually are paying 30ish of their take home into funds. Individual investments on a single deal are called an "American Waterfall" Vs a "European Waterfall," which is the whole fund. Each incentivization structure provides remarkably different issues. neither is perfect. BOth are prevalent in the market today. Flat cost structure funds exist as well. Also, remember all fees are just added to the costs the fund needs to return. So VCs are incentivized to keep them low, they many don't do this.

42 points by ilamont 3y ago

Even the most cynical of us were amazed by the fundamental lack of due diligence shown with FTX. If the people that funded that were asking you for more money then responding with scrutiny is at the polite end of possible responses. The problem VCs have is that the signal that a company is VC funded is now only a sign that the founders are connected. It says nothing about competence or ability to execute at all.

gunapologist99 3y ago
Do you think that VC's should be pulling credit reports or criminal background checks or something, like a bank? (And what would that have accomplished with SBF anyway?) Lots of founders don't have good credit, or maybe even any credit at all. Do we really want to make it even harder to raise? There is no "due diligence" that can detect when you've invested in a turkey, or even a turkey that later turns out to have combined funds (perhaps fraudulently) or practiced financial mismanagement to the point that he was bailing out Alameda with FTX funds. That's why you invest in a wide variety of things. FTX is why LPs might be hesitant to invest in Sequoia in the future, but the "variety" part might also be why they don't hesitate, too.
- blitzar 3y ago
  SBF presented himself as a shit talking bullshitter dosed up to the eyeballs on amphetamines. Not only did Sequoia notice that this was the case, but they loved it and threw as many fistfulls of cash as they could at it.
  - gunapologist99 3y ago
    Point taken, but he also presented himself as a brilliant (if slightly psychotic) nerd, which is exactly the archetype that has worked well for Sequoia in the past.
- AlexandrB 3y ago
  > Do you think that VC's should be pulling credit reports or criminal background checks or something, like a bank? It's funny to use this as some kind of absurd example when in many places this kind of stuff is standard before someone lets you rent an apartment. Isn't vetting founders and their companies before risking the LP's money part of the job for a VC?
  - gunapologist99 3y ago
    Of course, it is an absurd example. I'm sure SBF had great credit and no criminal background. Very few founders who would ever catch even the remotest VC interest would have any significant negatives, on paper anyway. SBF was seen as a catch because of his elitist and entrepreneurial background, with two professor parents at Stanford, a background on Wall Street, a hilariously affected backstory about international cryptocurrency arbitrage, crazy ideas on how his future wealth could (and would) save the world, and a later history of donating or bundling crazy amounts of money for his preferred political party (and anyone else in either party or agency that he could perhaps influence with donations). That's why checking credit report or even criminal background is so absurd in this context. Checks like this won't do anything except further entrench the elitist anti-meritocracy that currently infects the VC community. Lots of people can walk into a bank and get a loan, but very few can walk into Sand Hill Road and raise a round of any size.
malux85 3y ago
Yep, one of the recent places I have worked had a 19 year old founder and raised 6 million euros. Founder has no experience, a buggy non functioning mvp, no customers, no traction. He only got investment by plagiarising a paper that got cited a few times and then exploiting the fact that he fooled one clueless VC into giving them money so he must be good. This snowballed into other investors giving money. No technical DD, I spent 20 minutes reading the code when I started and could tell it was a whole bunch of nothing - a tiny system that creates a docker container but worse (reinventing the square wheel) Well he might have potential you say? Nope. It’s been 2 years and he has completely failed to execute and get even a minimal number of customers (I.E. the individual ones that try it immediately churn because it’s buggy and useless) It’s a complete circus, I can’t believe that a group of well known VC names are so clueless

a-posteriori 3y ago

Whenever I see articles like this I come back to Calpers venture returns over the last 20 years: > Calpers' venture returns have been historically lackluster. From 2000 to 2020, its venture performance was a dismal 0.49%, compared to 11.59% in buyouts. Calpers declined to comment. https://pitchbook.com/news/articles/calpers-venture-asset-class-tiger-lightspeed https://pitchbook.com/news/articles/calpers-venture-asset-cl... How LPs didn't take a step back and ask, "does this strategy work?". I don't know.

hef19898 3y ago
Hoping either for an IPO, SPAC or SoftBank? After all, people bet on horses, sports, play the lottery...
- Given_47 3y ago
  Sports is easy enough. The hardest part is getting around limits and finding new accounts cuz anyone with a brain inevitably gets kicked. But overall relatively easy side income
gumby 3y ago
When Calpers started reporting this info their portfolio companies (VCs like Sequoia) were furious and tried to block it. It exposed their made up IRR numbers to public view. But as a public agency, Calpers was able to stick to its guns and provide a valuable service. People forget how tiny the VC business is: just a pimple on the PE market. Typically it’s a tiny part of a big investor’s portfolio, just to have some exposure diversity. You can tell how important it is to them when you attend an LP meeting for a VC fund: the GPs may be bowing and scraping* but among the LPs’ representatives are a lot of 22 year old first year associates, which shows how unimportant the sector is to these big guys. * props to the GPs who are both not arrogant and not ingratiating to their customers (cough sorry, “LPs”). In my experience there are fewer than you would think.
- a-posteriori 3y ago
  Well put and I have also witnessed the same patterns at GP/LP meetings. Ironically, Calpers' excuse for their poor returns is that the "top tier" VCs (such as Sequoia) now exclude them due to their public reporting requirements, and therefore they are forced to deploy to tier 2 managers.

snisarenko 3y ago

I think we would see less poor VC investments if there was a practical way to short or bet against these investments. Currently the only punishment a bad VC gets, is that they still collect their fees, and get the wag of the finger from the rich people who gave them money.

dpflan 3y ago
So a derivatives market for betting an investment's success? Would that be effectively, a market for the (private) investment's stock?
- snisarenko 3y ago
  Yeah, I guess something like that. Other approach is for LPs to reject any percentage based management fees. I think a skin in the game payout structure for VCs would be better. - VC has to commit x% (5%)? of their net worth into the fund - VC gets bonus payouts only on individual investments that are net profitable (something like 3% of the net profit from the invested LP money) - Could also be augmented with a Flat Yearly Salary/Fee to cover basic operations (not a percentage based fee) If I was an LP thats how I would do it. No way would I agree to a flat percentage mangement fee.
  - smartbettor 3y ago
    I'm not sure if you know but all of this has been tried or is currently how it works. To begin with, most GP's have north of 5% of their net worth in the Funds or they're leveraged and borrowing against their homes etc. Partners usually are paying 30ish of their take home into funds. Individual investments on a single deal are called an "American Waterfall" Vs a "European Waterfall," which is the whole fund. Each incentivization structure provides remarkably different issues. neither is perfect. BOth are prevalent in the market today. Flat cost structure funds exist as well. Also, remember all fees are just added to the costs the fund needs to return. So VCs are incentivized to keep them low, they many don't do this.