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Remember: if VCs believed in what they were doing they would not take a 2% annual management fee and 20% of the upside. They’d take 40% of the upside and live

Remember: if VCs believed in what they were doing they would not take a 2% annual management fee and 20% of the upside. They’d take 40% of the upside and live on ramen noodles. VCs make money by raising money from LPs. They spend this money on investments which don’t look too bad if they fail, because nearly all of them fail. Looking good while losing all of your investors money on companies which go broke is the key VC skill. Once in a while you get a huge hit. That’s a lottery win, there is no formula for finding that hit. Broad bets helps but that’s about it. The “VC thesis” is a fundraising tool, a pitch instrument, it makes no measurable difference to success. It’s a shtick. Sympathy, however, for the VC: car dealership sized transactions paired with the diligence burdens of real finance. It’s a terrible job. Once you understand that VC is one of the worst jobs in finance and they don’t believe most of their own story — it’s fundraising flimflam for their LPs - it’s a lot easier to negotiate. 1) we are a sound bet not to get you in trouble if we fail (good schools and track records) 2) we will work hard on things which your LPs and their lawyers understand, leaving evidence of a good effort on failure 3) we know how the game works and will play by the unwritten rules: keep up appearances The kind of lunatics who actually stand to make money with a higher probability than average - the “Think Different” category - usually violate all of these rules. 1) they have no track record 2) they work on esoteric nonsense 3) they look weird in public And they’re structurally uninvestable. Once you get this it’s all a lot easier: the job of a VC is not to invest in winners, that’s a bonus. The job of a VC is to look respectable while losing other people’s money at the roulette wheel, and taking a margin for doing so. I hope that helps.

tomp 2y ago
This doesn't make sense. I worked in hedge funds, even there the management fee (2%) covers the fixed costs (legal, trading operations, treasury, IT operations, etc.) whereas the performance fee (20%) incentivises the alpha. In VC it's even worse, because at least hedge funds are liquid. VC investments don't realize their value for 5-10 years! Are they supposed to work for free for 10 years? Even the support staff?
- leashless 2y ago
  Take 40% and raise capital for the VC operations as a separate transaction than from the LPs, of course. Efficient markets.
  - SkyMarshal 2y ago
    How would you raise capital for operations separately from LPs? What's the upside of that for any investor? Do they get part of fund returns? Nobody is giving any kind of fund any money unless they get part of the fund returns for it.
    - leashless 2y ago
      They would take equity in the fund, of course.
  - notahacker 2y ago
    So they take 40% of future portfolio returns, and then sell half of that up front in return for investment of 2% of total funds managed and end up exactly where we are now but with added complexity....
- Negitivefrags 2y ago
  If they have fixed costs, why is it a percentage based fee? Why not just be upfront with a fixed dollar value per year of fees for that part?
  - LysPJ 2y ago
    Fees such as trading costs are a percentage of trading volume. Therefore, the more money you are managing, the higher your trading costs. (i.e those costs are "fixed" but its a "fixed percentage" rather than a static number.)
    - csomar 2y ago
      I highly doubt trading costs are part of the 2% management fee.
saberience 2y ago
This is nonsense... VCs have a whole staff of people needed to do business and a ton of costs. There's a legal team, marketing/events, human resources, finance, some executive assistants. Screening, meeting founders, traveling to meet founders, takes up a TON of time and obviously most of the time, no investments are made! Also don't forget, VCs have an office, usually not in a cheap place, so lease costs, cleaning costs etc. If VCs had to work for free, where would you be meeting them? Ok it's all virtual now, let's say. But the truth is, meeting people face to face when you're going to write them a cheque for 10-20M is generally a good idea. So VCs and founders will almost always need to travel. You're also always going to need lawyers and finance people, since you're dealing with term sheets and large amounts of money. As others have said, VC investments are not liquid at all and the timeline is 10 years for any returns. So a VC investor in your world has to travel around the US, Europe or India meeting founders, has to work with lawyers, financial folks for free, gets zero benefits in terms of healthcare, etc. All for the chance at 40% of something in 10+ years, that might not work out anyway? If run this way, the industry would simply not exist and the founders would not get any investment. And the truth is this, there are many founders out there who want and actively seek VC investment and "shock" actually are happy with the relationship with their investors because they understand a good relationship benefits both parties in the deal. I will also add, most employees in VC firms get no percentage of the profits of the fund (i.e. the carry). Most VC employees just get a regular salary (which is often far less than tech company salaries). So if there were no fee associated, these people would never get paid, since even when the fund finishes, they wouldn't get any of the 20% carry.
- leashless 2y ago
  As noted, the VC would raise capital like any other business to cover its operating costs. Think about why they don’t do that.
  - saberience 2y ago
    They already do that... they raise funds from LPs which include a fee which covers the costs. And it works fine, LPs repeatedly invest in the same firms which they wouldn't do if they thought it was a bad deal. There are firms which have been investing for 20-30 years with the same LPs. If the business model wasn't working it would have failed and the VC firm would have closed a long time ago.
chollida1 2y ago
> Remember: if VCs believed in what they were doing they would not take a 2% annual management fee and 20% of the upside. This makes no sense. Companies have fees, junior associates have student loans, buldings require rent to be paid. This is a foolish sentiment, unless you would apply it to all employees everywhere. If startup employees truly believe in their company they would also take no salary at all and just live on ramen noodles. But if you think this through you realize that employees also have costs in their lives that they need money for. > Once you get this it’s all a lot easier: the job of a VC is not to invest in winners, that’s a bonus. > The job of a VC is to look respectable while losing other people’s money at the roulette wheel, and taking a margin for doing so. This really makes me question which VC firm you work at as you don't seem to understand how they work. If VC firms had no alpha then they wouldn't be able to raise a second fund at all. And you'd never see VC funds stick around. They fact that Y combinator exists for all these years and A16Z, sequoia, etc are all around for so long indicates that they are good at their job and their job is to make returns for the LPs. I work at a firm, i'd be happy to help you understand how these firms work as you seem to have a very outsiders view on it, i can help clear up alot of your blind spots if you want to talk!!
- leashless 2y ago
  VC as an asset class loses money. Within that loss, some companies do better than others. Whether that is skill, luck or finding some way to tilt the board in your favour (political influence for example) depends on who you ask. I have read that the statistics the distribution of success in the VC field was compatible with a random distribution with a very small skill bias. I do not know if that analysis was accurate and it will be 10 years out of date now. But that there are winners and losers does not mean that it is not a game of chance.
  - b112 2y ago
    Do you know if those stats took into account massive economic events? Such as market crashes? Which tend to happen at least once a decade? People often have a point to make, and will often ignore such data to make it. To add to this, outside of honest intent prejudiced with personal bias, there are parties lookong to undermine any aspect of success the West has, by invalidating those successful models.
raincole 2y ago
> if VCs believed in what they were doing they would not take a 2% annual management fee and 20% of the upside. They’d take 40% of the upside and live on ramen noodles So if you believed in something, you need to get rid of the concept of hedging and financial responsibility? This kind of "believing" is what a religious zealot does. No wonder people say SV is a cult.
davedx 2y ago
Elegantly written presumption.
DEDLINE 2y ago
This is an incredible post for me. You need to have a marketable CV, you need to have a few growth metrics and you need to be in on the joke.
- leashless 2y ago
  Yes. I learned this the hard way. I'm glad to see people _getting it_! Good luck!
deleted 2y ago
[deleted]
leashless 2y ago
Paul Graham, Black Swan Farming: https://paulgraham.com/swan.html https://paulgraham.com/swan.html > "The two most important things to understand about startup investing, as a business, are (1) that effectively all the returns are concentrated in a few big winners, and (2) that the best ideas look initially like bad ideas." _initially look like bad ideas_ meaning "we can't pick them out of the crowd of other bad ideas" > "there is probably at most one company in each YC batch that will have a significant effect on our returns, and the rest are just a cost of doing business" > "For that reason one of my most valuable memories is how lame Facebook sounded to me when I first heard about it." > "We'll probably never be able to bring ourselves to take risks proportionate to the returns in this business." So it's not like this model is alien to Our Kind Hosts at YC. They understand that this is a crap shoot with a slightly tilted table, but they're optimising for staying out of the zones where everybody else is betting and not that much more. To be remembered: if you're having a hard time getting funded, the VCs are also having a hard time funding you, because the huge returns go to things that look odd, lame, and weird. For the most part.
- jerrygenser 2y ago
  > So it's not like this model is alien to Our Kind Hosts at YC. They understand that this is a crap shoot with a slightly tilted table, but they're optimising for staying out of the zones where everybody else is betting and not that much more. Do you think this still applies, given recent waves of following the crowd in the last few years like crypto, and now AI? It seems that YC is actually in exactly the same hype zones as everyone else these days.
  - leashless 2y ago
    I'm too far away to know: based in London, mostly working in the legaltech domain, we're far far away from the SV cultural nexus (other than occasional trips to Burning Man for a refresher!) I think there's a pretty good chance that as their original team is further and further from the operation that they're "reverting to the mean" but I have no evidence.
admissionsguy 2y ago
This makes a lot of sense. I have always wondered how it is that VCs give so much weight to perceptions. Coming from academic background, it seems so strange that your school rank weights much more in getting VC funding than in PhD admissions.
data_maan 2y ago
Cool description :)
edouard-harris 2y ago
This correctly describes bad VCs, but not good ones. In my experience, the vast majority of VCs from outside the Bay Area are bad in this way (particularly true in Europe). Not all VCs from the Bay Area are good, but the good ones are far more common there than anywhere else. One reason "move to SF" is such common advice.
lemonwaterlime 2y ago
This is the correct take, though it states a truth many don’t want to hear. Even the detractors have not been able to make solid counter arguments. Instead, they pile on hypotheticals to try and overwhelm this comment author (miring in bureaucracy).

tomp 2y ago

This doesn't make sense. I worked in hedge funds, even there the management fee (2%) covers the fixed costs (legal, trading operations, treasury, IT operations, etc.) whereas the performance fee (20%) incentivises the alpha. In VC it's even worse, because at least hedge funds are liquid. VC investments don't realize their value for 5-10 years! Are they supposed to work for free for 10 years? Even the support staff?

leashless 2y ago
Take 40% and raise capital for the VC operations as a separate transaction than from the LPs, of course. Efficient markets.
- SkyMarshal 2y ago
  How would you raise capital for operations separately from LPs? What's the upside of that for any investor? Do they get part of fund returns? Nobody is giving any kind of fund any money unless they get part of the fund returns for it.
  - leashless 2y ago
    They would take equity in the fund, of course.
- notahacker 2y ago
  So they take 40% of future portfolio returns, and then sell half of that up front in return for investment of 2% of total funds managed and end up exactly where we are now but with added complexity....
Negitivefrags 2y ago
If they have fixed costs, why is it a percentage based fee? Why not just be upfront with a fixed dollar value per year of fees for that part?
- LysPJ 2y ago
  Fees such as trading costs are a percentage of trading volume. Therefore, the more money you are managing, the higher your trading costs. (i.e those costs are "fixed" but its a "fixed percentage" rather than a static number.)
  - csomar 2y ago
    I highly doubt trading costs are part of the 2% management fee.

saberience 2y ago

This is nonsense... VCs have a whole staff of people needed to do business and a ton of costs. There's a legal team, marketing/events, human resources, finance, some executive assistants. Screening, meeting founders, traveling to meet founders, takes up a TON of time and obviously most of the time, no investments are made! Also don't forget, VCs have an office, usually not in a cheap place, so lease costs, cleaning costs etc. If VCs had to work for free, where would you be meeting them? Ok it's all virtual now, let's say. But the truth is, meeting people face to face when you're going to write them a cheque for 10-20M is generally a good idea. So VCs and founders will almost always need to travel. You're also always going to need lawyers and finance people, since you're dealing with term sheets and large amounts of money. As others have said, VC investments are not liquid at all and the timeline is 10 years for any returns. So a VC investor in your world has to travel around the US, Europe or India meeting founders, has to work with lawyers, financial folks for free, gets zero benefits in terms of healthcare, etc. All for the chance at 40% of something in 10+ years, that might not work out anyway? If run this way, the industry would simply not exist and the founders would not get any investment. And the truth is this, there are many founders out there who want and actively seek VC investment and "shock" actually are happy with the relationship with their investors because they understand a good relationship benefits both parties in the deal. I will also add, most employees in VC firms get no percentage of the profits of the fund (i.e. the carry). Most VC employees just get a regular salary (which is often far less than tech company salaries). So if there were no fee associated, these people would never get paid, since even when the fund finishes, they wouldn't get any of the 20% carry.

leashless 2y ago
As noted, the VC would raise capital like any other business to cover its operating costs. Think about why they don’t do that.
- saberience 2y ago
  They already do that... they raise funds from LPs which include a fee which covers the costs. And it works fine, LPs repeatedly invest in the same firms which they wouldn't do if they thought it was a bad deal. There are firms which have been investing for 20-30 years with the same LPs. If the business model wasn't working it would have failed and the VC firm would have closed a long time ago.

chollida1 2y ago

> Remember: if VCs believed in what they were doing they would not take a 2% annual management fee and 20% of the upside. This makes no sense. Companies have fees, junior associates have student loans, buldings require rent to be paid. This is a foolish sentiment, unless you would apply it to all employees everywhere. If startup employees truly believe in their company they would also take no salary at all and just live on ramen noodles. But if you think this through you realize that employees also have costs in their lives that they need money for. > Once you get this it’s all a lot easier: the job of a VC is not to invest in winners, that’s a bonus. > The job of a VC is to look respectable while losing other people’s money at the roulette wheel, and taking a margin for doing so. This really makes me question which VC firm you work at as you don't seem to understand how they work. If VC firms had no alpha then they wouldn't be able to raise a second fund at all. And you'd never see VC funds stick around. They fact that Y combinator exists for all these years and A16Z, sequoia, etc are all around for so long indicates that they are good at their job and their job is to make returns for the LPs. I work at a firm, i'd be happy to help you understand how these firms work as you seem to have a very outsiders view on it, i can help clear up alot of your blind spots if you want to talk!!

leashless 2y ago
VC as an asset class loses money. Within that loss, some companies do better than others. Whether that is skill, luck or finding some way to tilt the board in your favour (political influence for example) depends on who you ask. I have read that the statistics the distribution of success in the VC field was compatible with a random distribution with a very small skill bias. I do not know if that analysis was accurate and it will be 10 years out of date now. But that there are winners and losers does not mean that it is not a game of chance.
- b112 2y ago
  Do you know if those stats took into account massive economic events? Such as market crashes? Which tend to happen at least once a decade? People often have a point to make, and will often ignore such data to make it. To add to this, outside of honest intent prejudiced with personal bias, there are parties lookong to undermine any aspect of success the West has, by invalidating those successful models.

raincole 2y ago

> if VCs believed in what they were doing they would not take a 2% annual management fee and 20% of the upside. They’d take 40% of the upside and live on ramen noodles So if you believed in something, you need to get rid of the concept of hedging and financial responsibility? This kind of "believing" is what a religious zealot does. No wonder people say SV is a cult.

davedx 2y ago

Elegantly written presumption.

DEDLINE 2y ago

This is an incredible post for me. You need to have a marketable CV, you need to have a few growth metrics and you need to be in on the joke.

leashless 2y ago
Yes. I learned this the hard way. I'm glad to see people _getting it_! Good luck!

deleted 2y ago

[deleted]

leashless 2y ago

Paul Graham, Black Swan Farming: https://paulgraham.com/swan.html https://paulgraham.com/swan.html > "The two most important things to understand about startup investing, as a business, are (1) that effectively all the returns are concentrated in a few big winners, and (2) that the best ideas look initially like bad ideas." _initially look like bad ideas_ meaning "we can't pick them out of the crowd of other bad ideas" > "there is probably at most one company in each YC batch that will have a significant effect on our returns, and the rest are just a cost of doing business" > "For that reason one of my most valuable memories is how lame Facebook sounded to me when I first heard about it." > "We'll probably never be able to bring ourselves to take risks proportionate to the returns in this business." So it's not like this model is alien to Our Kind Hosts at YC. They understand that this is a crap shoot with a slightly tilted table, but they're optimising for staying out of the zones where everybody else is betting and not that much more. To be remembered: if you're having a hard time getting funded, the VCs are also having a hard time funding you, because the huge returns go to things that look odd, lame, and weird. For the most part.

jerrygenser 2y ago
> So it's not like this model is alien to Our Kind Hosts at YC. They understand that this is a crap shoot with a slightly tilted table, but they're optimising for staying out of the zones where everybody else is betting and not that much more. Do you think this still applies, given recent waves of following the crowd in the last few years like crypto, and now AI? It seems that YC is actually in exactly the same hype zones as everyone else these days.
- leashless 2y ago
  I'm too far away to know: based in London, mostly working in the legaltech domain, we're far far away from the SV cultural nexus (other than occasional trips to Burning Man for a refresher!) I think there's a pretty good chance that as their original team is further and further from the operation that they're "reverting to the mean" but I have no evidence.

admissionsguy 2y ago

This makes a lot of sense. I have always wondered how it is that VCs give so much weight to perceptions. Coming from academic background, it seems so strange that your school rank weights much more in getting VC funding than in PhD admissions.

data_maan 2y ago

Cool description :)

edouard-harris 2y ago

This correctly describes bad VCs, but not good ones. In my experience, the vast majority of VCs from outside the Bay Area are bad in this way (particularly true in Europe). Not all VCs from the Bay Area are good, but the good ones are far more common there than anywhere else. One reason "move to SF" is such common advice.

lemonwaterlime 2y ago

This is the correct take, though it states a truth many don’t want to hear. Even the detractors have not been able to make solid counter arguments. Instead, they pile on hypotheticals to try and overwhelm this comment author (miring in bureaucracy).