4 ms·

VC Insanity, Explained

109 points by xyzzyrz 15y ago

lionhearted 15y ago
It's an insightful explanation - the structure of funds, expectations of LPs, common practices in the industry, and reputation concerns lead to some incentives that are logical for a VC to follow, but perhaps inoptimum.
- einhverfr 15y ago
  So it also explains why so many VC's do not want businesses to bootstrap.
jonmrodriguez 15y ago
Why is there no recycling? It seems like a no-brainer to for the LP to allow recycling, so maybe I'm failing to see some perverse incentive that would exist if recycling were allowed?
- pge 15y ago
  Most funds allow for recycling within defined parameters of total dollars or time frame. VCs and LPs are not ignorant, and the issues raised in the article are not new. In most of the funds whose legal structure I am familiar with, a 2x return in a year would be welcome, and the original invested capital would be recyclable into new investments to create further return.
- danshapiro 15y ago
  There is actually some recycling allowed, as described in the "disclaimer" section. But the reason is interesting: Many organizations that invest in VCs are extremely efficient, analytical operations. They model each investment in their portfolio carefully. Imagine you are considering playing blackjack at a $1-per-bet table. You start with $100. You play well, so you expect to end up with about $97, since with good play, the house edge is about 3%. Two hours later, all your money is gone! Did you lose every time? No. But you re-invested the proceeds of each game, and that modified your return expectations. Similarly, when VCs have unlimited re-investment, it plays havoc with their investors' return calculations. Also - separate issue - if you re-invest late in a fund's life, you increase the odds that the fund closes up shop while it still has a bunch of active companies in its portfolio. So while it's not prohibited outright, it's often restricted, and knowing that can help you understand certain behaviors.
pge 15y ago
Articles like this, which paint VCs with perjorative stereotypes (e.g. "Golf games get abbreviated.") are not helpful. As long as you consider the VC an "other" - a different species from you, you won't be able to work constructively with one. Anytime we paint another group of people as an "other" whether because of race or culture or whatever, we do our selves a disservice and encourage conflict and misunderstanding. We're all people, and we're all pretty much the same. A VC is just an entrepreneur whose line of business is money management instead of software development. If you want to understand the differences between money management and software development and what that means for how VCs try to build a successful business in that industry, go talk to VCs. But approach the conversation as a peer and fellow entrepreneur, not as someone trying to understand an alien.
- michaelochurch 15y ago
  Anytime we paint another group of people as an "other" whether because of race or culture or whatever, we do our selves a disservice and encourage conflict and misunderstanding. It goes both ways, though. VCs still make entrepreneurs pay the VCs' own (!) legal fees, they still roll out criminal terms like participating preferred and multiple liquidation preferences ("because fuck you, that's why") which are essentially legitimized extortion, and they still take months to make decisions that could be made in under a week with appropriate masculinity. Terms and behaviors like that emphasize the separation: you're not among us, and this is what you'll deal with for the right to breathe the same air as we do. Why do they get away with this? Because most of them look out for each other, not entrepreneurs. Because if you don't take that "deal" with the 4x liquidation preference and participating preferred, the VC offering it is going to call up 6 other VCs and damage your reputation and they will lose interest as well (the extortion factor). The two-class world still exists, and unless you worked directly with Mark Zuckerberg, VCs are of a higher class than entrepreneurs and they don't even want to share an elevator with you. It shouldn't be that way, but it is. Yes, being an entrepreneur is more fun when things are going smashingly well, but VCs don't have to worry about their kids' school bills when things aren't going well. Plus, VCs can always become entrepreneurs and have a leg up (from the connections and inside track they established while in VC) when they do so. The 25th-percentile outcome for a VC is that he doesn't make partner but gets an executive position at a portfolio company. The 25th-percentile outcome for an entrepreneur is, for a hint, not the option to go into VC for a few years.
alok-g 15y ago
Previous discussion: http://news.ycombinator.com/item?id=1598728 http://news.ycombinator.com/item?id=1598728
draggnar 15y ago
> It’s 10x return on what they reserved to invest – a bigger number that takes in to account the total amount they predicted you’d need over the course of your company’s future Does anyone know of any examples where a VC did not allow a sale to happen because they were going to do another round? The argument here makes logical sense but I have never actually seen an example of this.
- apenwarr 15y ago
  It's not "because they want to do another round." They don't necessarily want to give you the extra money, but the final amount of their return does need to be a multiple of the number they could have invested, not the number they did invest. Thus they need your company to grow more than you might think they do, and they could block a sale in the hopes that will happen. If you end up needing more investment after the sale has been blocked, that's fine, because they have money in reserve, but actually giving you the money is not the overwhelming motivation.
  - draggnar 15y ago
    That makes sense. Is sales being blocked by investors a common thing?

109 points by xyzzyrz 15y ago

It's an insightful explanation - the structure of funds, expectations of LPs, common practices in the industry, and reputation concerns lead to some incentives that are logical for a VC to follow, but perhaps inoptimum.

einhverfr 15y ago
So it also explains why so many VC's do not want businesses to bootstrap.

jonmrodriguez 15y ago

Why is there no recycling? It seems like a no-brainer to for the LP to allow recycling, so maybe I'm failing to see some perverse incentive that would exist if recycling were allowed?

pge 15y ago
Most funds allow for recycling within defined parameters of total dollars or time frame. VCs and LPs are not ignorant, and the issues raised in the article are not new. In most of the funds whose legal structure I am familiar with, a 2x return in a year would be welcome, and the original invested capital would be recyclable into new investments to create further return.
danshapiro 15y ago
There is actually some recycling allowed, as described in the "disclaimer" section. But the reason is interesting: Many organizations that invest in VCs are extremely efficient, analytical operations. They model each investment in their portfolio carefully. Imagine you are considering playing blackjack at a $1-per-bet table. You start with $100. You play well, so you expect to end up with about $97, since with good play, the house edge is about 3%. Two hours later, all your money is gone! Did you lose every time? No. But you re-invested the proceeds of each game, and that modified your return expectations. Similarly, when VCs have unlimited re-investment, it plays havoc with their investors' return calculations. Also - separate issue - if you re-invest late in a fund's life, you increase the odds that the fund closes up shop while it still has a bunch of active companies in its portfolio. So while it's not prohibited outright, it's often restricted, and knowing that can help you understand certain behaviors.

pge 15y ago

Articles like this, which paint VCs with perjorative stereotypes (e.g. "Golf games get abbreviated.") are not helpful. As long as you consider the VC an "other" - a different species from you, you won't be able to work constructively with one. Anytime we paint another group of people as an "other" whether because of race or culture or whatever, we do our selves a disservice and encourage conflict and misunderstanding. We're all people, and we're all pretty much the same. A VC is just an entrepreneur whose line of business is money management instead of software development. If you want to understand the differences between money management and software development and what that means for how VCs try to build a successful business in that industry, go talk to VCs. But approach the conversation as a peer and fellow entrepreneur, not as someone trying to understand an alien.

michaelochurch 15y ago
Anytime we paint another group of people as an "other" whether because of race or culture or whatever, we do our selves a disservice and encourage conflict and misunderstanding. It goes both ways, though. VCs still make entrepreneurs pay the VCs' own (!) legal fees, they still roll out criminal terms like participating preferred and multiple liquidation preferences ("because fuck you, that's why") which are essentially legitimized extortion, and they still take months to make decisions that could be made in under a week with appropriate masculinity. Terms and behaviors like that emphasize the separation: you're not among us, and this is what you'll deal with for the right to breathe the same air as we do. Why do they get away with this? Because most of them look out for each other, not entrepreneurs. Because if you don't take that "deal" with the 4x liquidation preference and participating preferred, the VC offering it is going to call up 6 other VCs and damage your reputation and they will lose interest as well (the extortion factor). The two-class world still exists, and unless you worked directly with Mark Zuckerberg, VCs are of a higher class than entrepreneurs and they don't even want to share an elevator with you. It shouldn't be that way, but it is. Yes, being an entrepreneur is more fun when things are going smashingly well, but VCs don't have to worry about their kids' school bills when things aren't going well. Plus, VCs can always become entrepreneurs and have a leg up (from the connections and inside track they established while in VC) when they do so. The 25th-percentile outcome for a VC is that he doesn't make partner but gets an executive position at a portfolio company. The 25th-percentile outcome for an entrepreneur is, for a hint, not the option to go into VC for a few years.

alok-g 15y ago

Previous discussion: http://news.ycombinator.com/item?id=1598728 http://news.ycombinator.com/item?id=1598728

draggnar 15y ago

> It’s 10x return on what they reserved to invest – a bigger number that takes in to account the total amount they predicted you’d need over the course of your company’s future Does anyone know of any examples where a VC did not allow a sale to happen because they were going to do another round? The argument here makes logical sense but I have never actually seen an example of this.

apenwarr 15y ago
It's not "because they want to do another round." They don't necessarily want to give you the extra money, but the final amount of their return does need to be a multiple of the number they could have invested, not the number they did invest. Thus they need your company to grow more than you might think they do, and they could block a sale in the hopes that will happen. If you end up needing more investment after the sale has been blocked, that's fine, because they have money in reserve, but actually giving you the money is not the overwhelming motivation.
- draggnar 15y ago
  That makes sense. Is sales being blocked by investors a common thing?