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Just some examination of the math: If the VC firm is taking 15% of your company for $15m, then you've got a valuation of $100m. As far as I know, the "We all k

Just some examination of the math: If the VC firm is taking 15% of your company for $15m, then you've got a valuation of $100m. As far as I know, the "We all know that nine out of ten startups fail" applies to all startups, not the ones that are being valued at $100m. Also, I think very few VCs are investing $15m into a company that they expect to have a 90% chance of failure. You're looking at more of a 3-5x on some of the deals to carry the consistent 1-2x that the rest of the portfolio is returning. I don't disagree with a lot of the points in the article, but saying that a VC firm with a $150m fund is betting the farm on one $15m investment exiting at $3bn should raise some eyebrows.

pgeorgi 13y ago
So the numbers are simplified to make it easy to follow the general point. If they line up _that_ neatly, they usually are.
- andrewchoi 13y ago
  What I'm saying is that there are very few VCs that are hoping for a 30x on one investment to make up for 9 failures. It's an order of magnitude difference, which I think is nontrivial. If it was a general point, it would have been fine, but the difference between a $100m --> $300m company and a $100m --> $3000m company are huge.
phillmv 13y ago
The way I interpreted it was more, failure in VC terms is "not blowing up". That $15 mil investment might be acquihired, or continue to be unexcitingly profitable, or put up on the chopping block for its patent portfolio. They might not even lose money, but. Also keep in mind that VC funds as an asset class are historically a bad investment: http://www.slate.com/blogs/moneybox/2012/05/07/most_venture_capital_firms_suck.html http://www.slate.com/blogs/moneybox/2012/05/07/most_venture_... http://avc.com/2013/02/venture-capital-returns/ http://avc.com/2013/02/venture-capital-returns/ It's not just that the VC expects the average startup to fail; it's also expected that the average VC fails - or at least underperforms the S&P500.
- andrewchoi 13y ago
  I agree, especially in light of the preference structures that she mentions (and that I believe are industry-standard). But these arguments seem to lead to the conclusion that you shouldn't be an LP, not that you shouldn't take venture money. The only way that this becomes an issue is if the VC has enough of a stake to run their own decision making and executing process, and that (as I understand it) is the line between VC and PE.
  - phillmv 13y ago
    >But these arguments seem to lead to the conclusion that you shouldn't be an LP, not that you shouldn't take venture money. I have a very limited understanding, but the impression I got is that VCs typically have short maturity dates and thus are riskier in nature, whereas PE funds typically have the luxury of biding their time. How this is structured, or why exactly is beyond my ken. So upside being, VCs are incentivized to encourage larger risk taking than what would be otherwise optimal from the perspective of a bootstrapped founder.
    - andrewchoi 13y ago
      I can't speak for the PE side, but VCs aren't investing their own money. They have limited partners (LPs) that provide the money, and expect returns on it. This LP money goes into funds (vehicles to make investments out of). Each fund has a limited lifespan (the company I work for has fund lifetimes of around 8-10 years). This means that all of the money should be returned to investors over that time period. Since VCs can't make all of their investments at the beginning of the fund (for many reasons, chief among them scarcity) they need to show returns in an even shorter timeframe. The bootstrapped founder, on the other hand, doesn't necessarily need to exit the investment in those 8-10 (or shorter) years. There are, of course, serial entrepreneurs for whom that is their goal, and for them (as the article points out) their incentives are aligned. For "lifestyle company" founders (not meant to be disparaging), an exit may not be necessary at all. The key differences are time horizon and exit.
  - foysavas 13y ago
scootklein 13y ago
Just looking at YCs returns, the vast majority of the wealth appears to be concentrated into 3 of 600+ starts (Dropbox, AirBnB, and Stripe). Even a Heroku sale for 200M+ is a drop in the bucket compared to $10B private market valuation, say it out loud and it will sound weird. "Dropbox is worth 50 Herokus" Betting the farm implies that they have no other options, which is not the case with VCs, and it's impossible to know which will be their "super unicorns" when they write the checks, so they write lots of checks. There's not much reason to believe YC is unlike other angel groups, individuals, or VC firms, and their data should back up that the majority of their returns is 1 or 2 companies every so often with huge wins.
- andrewchoi 13y ago
  The difference is that YC isn't investing $15m into companies, they're investing $20k. The corresponding valuations for the companies that they invest in is $1m on the high end (20k / 2%), not $100m. The risk profile for different check sizes is vastly different.
  - scootklein 13y ago
    The risk profile as you seem to be thinking of it is an irrelevant metric when you're only interested in the return profile. They're optimizing for dollars returned, not % of companies sold for greater than money put in. Consider a "soft landing" (VC gets their money back), vs complete death (VC gets no money back). When put alongside a $3B acquisition they're both completely irrelevant, even if on paper the 1x money back is not considered a "failure". Check size doesn't appear to matter, the data for YC and for VC that I've seen suggests a similar power-law-ish distribution of returns.
    - andrewchoi 13y ago
      Nitpick: VCs are optimizing for % return, not on an dollar return basis. I would say that the risk profile is not irrelevant: if you're betting that 1/10 of your investments are returning your fund, then just one miss is the difference between a good year and "I don't have a VC firm anymore". Compare that to betting that half of your investments are returning your fund: one miss is the difference between a good year and an "ehh" year.[0] That's true; when you compare both of them to a 30x, the difference between a 1x and 0x is small. But what I'm saying is that at a $15m investment, very few VCs expect to see a 30x, and when you compare it vs. a 3x or a 5x acquisition, the difference between no money back and your 1x liquidation pref paying out is much larger, proportionally. The same power law may apply, but you see more of the tails in when you have a much larger sample size. If there were just as many $15m investments happening as $20k investments, you'd see the same result, but there aren't. Off-topic: are you the same Scott Klein I talked to over the summer re: statuspage.io? [0] Of course, that glosses over different probabilities of success and failure, but what I'm trying to say is that VCs are risk averse.
exelius 13y ago
Partially true; practically not. Most VC funds do have exit dates and specific life spans (typically 7-10 years). The way it was explained to me that if you have 10 companies in your portfolio, by year 7 you will have: * 3 total busts. Out of business; zero return on investment. * 4 "walking dead". Still in business, but just barely breaking even. Might as well be zero return because these investments are not liquid (who wants to buy a 7-year-old risky business with no profit?) Anymore these end up as acqui-hires with the VC getting pennies on the dollar. * 2 minor successes. Good, profitable companies that will probably never produce a hockey-stick graph. 2x-3x return. * 1 home run. If you're lucky. 10x return (though usually closer to 5x). Her example was bad, but it was just an example. VC is a tough industry to actually make any money in. VCs don't pressure founders to do things because they are greedy, it's because they're scared of losing their shirts.
- wpietri 13y ago
  Some actual numbers from Fred Wilson are here: http://www.usv.com/posts/why-early-stage-venture-investments-fail http://www.usv.com/posts/why-early-stage-venture-investments... He makes the interesting point that 2/3rds of his successful investments made major changes along the way.
  - deleted 13y ago
    [deleted]
  - exelius 13y ago
    Big changes in approach are inevitable in early-stage companies: things become apparent after 1-2 years that weren't initially. Early stage companies involve so much uncertainty that trying to stick to a plan for the sake of sticking to a plan is folly. His numbers are in a different context; but I get his point. Venture investing is a portfolio business; you fully expect a high failure rate.
eloisant 13y ago
Maybe the numbers could have been better chosen, but the message is correct: when you raise money, you're raising the bar for what will be called success. This is especially important now that infrastructure is close to free, it's easier now to bootstrap your company or even start it as a week-end hobby. That wasn't true in the 90s or early 2000s when you had to buy costly servers and hosting just to get started. So it is very important to know what your goal is. You want to get a slight chance to be the next Google or Facebook? You'd better raise money. You want to build a sustainable company for you and a small number of employees? Maybe raising is not the best thing to do.

pgeorgi 13y ago

So the numbers are simplified to make it easy to follow the general point. If they line up _that_ neatly, they usually are.

andrewchoi 13y ago
What I'm saying is that there are very few VCs that are hoping for a 30x on one investment to make up for 9 failures. It's an order of magnitude difference, which I think is nontrivial. If it was a general point, it would have been fine, but the difference between a $100m --> $300m company and a $100m --> $3000m company are huge.

phillmv 13y ago

The way I interpreted it was more, failure in VC terms is "not blowing up". That $15 mil investment might be acquihired, or continue to be unexcitingly profitable, or put up on the chopping block for its patent portfolio. They might not even lose money, but. Also keep in mind that VC funds as an asset class are historically a bad investment: http://www.slate.com/blogs/moneybox/2012/05/07/most_venture_capital_firms_suck.html http://www.slate.com/blogs/moneybox/2012/05/07/most_venture_... http://avc.com/2013/02/venture-capital-returns/ http://avc.com/2013/02/venture-capital-returns/ It's not just that the VC expects the average startup to fail; it's also expected that the average VC fails - or at least underperforms the S&P500.

andrewchoi 13y ago
I agree, especially in light of the preference structures that she mentions (and that I believe are industry-standard). But these arguments seem to lead to the conclusion that you shouldn't be an LP, not that you shouldn't take venture money. The only way that this becomes an issue is if the VC has enough of a stake to run their own decision making and executing process, and that (as I understand it) is the line between VC and PE.
- phillmv 13y ago
  >But these arguments seem to lead to the conclusion that you shouldn't be an LP, not that you shouldn't take venture money. I have a very limited understanding, but the impression I got is that VCs typically have short maturity dates and thus are riskier in nature, whereas PE funds typically have the luxury of biding their time. How this is structured, or why exactly is beyond my ken. So upside being, VCs are incentivized to encourage larger risk taking than what would be otherwise optimal from the perspective of a bootstrapped founder.
  - andrewchoi 13y ago
    I can't speak for the PE side, but VCs aren't investing their own money. They have limited partners (LPs) that provide the money, and expect returns on it. This LP money goes into funds (vehicles to make investments out of). Each fund has a limited lifespan (the company I work for has fund lifetimes of around 8-10 years). This means that all of the money should be returned to investors over that time period. Since VCs can't make all of their investments at the beginning of the fund (for many reasons, chief among them scarcity) they need to show returns in an even shorter timeframe. The bootstrapped founder, on the other hand, doesn't necessarily need to exit the investment in those 8-10 (or shorter) years. There are, of course, serial entrepreneurs for whom that is their goal, and for them (as the article points out) their incentives are aligned. For "lifestyle company" founders (not meant to be disparaging), an exit may not be necessary at all. The key differences are time horizon and exit.
- foysavas 13y ago

scootklein 13y ago

Just looking at YCs returns, the vast majority of the wealth appears to be concentrated into 3 of 600+ starts (Dropbox, AirBnB, and Stripe). Even a Heroku sale for 200M+ is a drop in the bucket compared to $10B private market valuation, say it out loud and it will sound weird. "Dropbox is worth 50 Herokus" Betting the farm implies that they have no other options, which is not the case with VCs, and it's impossible to know which will be their "super unicorns" when they write the checks, so they write lots of checks. There's not much reason to believe YC is unlike other angel groups, individuals, or VC firms, and their data should back up that the majority of their returns is 1 or 2 companies every so often with huge wins.

andrewchoi 13y ago
The difference is that YC isn't investing $15m into companies, they're investing $20k. The corresponding valuations for the companies that they invest in is $1m on the high end (20k / 2%), not $100m. The risk profile for different check sizes is vastly different.
- scootklein 13y ago
  The risk profile as you seem to be thinking of it is an irrelevant metric when you're only interested in the return profile. They're optimizing for dollars returned, not % of companies sold for greater than money put in. Consider a "soft landing" (VC gets their money back), vs complete death (VC gets no money back). When put alongside a $3B acquisition they're both completely irrelevant, even if on paper the 1x money back is not considered a "failure". Check size doesn't appear to matter, the data for YC and for VC that I've seen suggests a similar power-law-ish distribution of returns.
  - andrewchoi 13y ago
    Nitpick: VCs are optimizing for % return, not on an dollar return basis. I would say that the risk profile is not irrelevant: if you're betting that 1/10 of your investments are returning your fund, then just one miss is the difference between a good year and "I don't have a VC firm anymore". Compare that to betting that half of your investments are returning your fund: one miss is the difference between a good year and an "ehh" year.[0] That's true; when you compare both of them to a 30x, the difference between a 1x and 0x is small. But what I'm saying is that at a $15m investment, very few VCs expect to see a 30x, and when you compare it vs. a 3x or a 5x acquisition, the difference between no money back and your 1x liquidation pref paying out is much larger, proportionally. The same power law may apply, but you see more of the tails in when you have a much larger sample size. If there were just as many $15m investments happening as $20k investments, you'd see the same result, but there aren't. Off-topic: are you the same Scott Klein I talked to over the summer re: statuspage.io? [0] Of course, that glosses over different probabilities of success and failure, but what I'm trying to say is that VCs are risk averse.

exelius 13y ago

Partially true; practically not. Most VC funds do have exit dates and specific life spans (typically 7-10 years). The way it was explained to me that if you have 10 companies in your portfolio, by year 7 you will have: * 3 total busts. Out of business; zero return on investment. * 4 "walking dead". Still in business, but just barely breaking even. Might as well be zero return because these investments are not liquid (who wants to buy a 7-year-old risky business with no profit?) Anymore these end up as acqui-hires with the VC getting pennies on the dollar. * 2 minor successes. Good, profitable companies that will probably never produce a hockey-stick graph. 2x-3x return. * 1 home run. If you're lucky. 10x return (though usually closer to 5x). Her example was bad, but it was just an example. VC is a tough industry to actually make any money in. VCs don't pressure founders to do things because they are greedy, it's because they're scared of losing their shirts.

wpietri 13y ago
Some actual numbers from Fred Wilson are here: http://www.usv.com/posts/why-early-stage-venture-investments-fail http://www.usv.com/posts/why-early-stage-venture-investments... He makes the interesting point that 2/3rds of his successful investments made major changes along the way.
- deleted 13y ago
  [deleted]
- exelius 13y ago
  Big changes in approach are inevitable in early-stage companies: things become apparent after 1-2 years that weren't initially. Early stage companies involve so much uncertainty that trying to stick to a plan for the sake of sticking to a plan is folly. His numbers are in a different context; but I get his point. Venture investing is a portfolio business; you fully expect a high failure rate.

eloisant 13y ago

Maybe the numbers could have been better chosen, but the message is correct: when you raise money, you're raising the bar for what will be called success. This is especially important now that infrastructure is close to free, it's easier now to bootstrap your company or even start it as a week-end hobby. That wasn't true in the 90s or early 2000s when you had to buy costly servers and hosting just to get started. So it is very important to know what your goal is. You want to get a slight chance to be the next Google or Facebook? You'd better raise money. You want to build a sustainable company for you and a small number of employees? Maybe raising is not the best thing to do.