
Reasons Not To Raise Venture Capital - aaronbrethorst
http://modelviewculture.com/pieces/five-reasons-not-to-raise-venture-capital
======
ChuckMcM
You just need this sentence:

 _" VCs aren’t unintelligent. Nor are VCs evil (not all of them anyway).
They’re not even necessarily misaligned with you. What they are doing is
optimizing for a very specific outcome. Share that alignment, or don’t take
their money."_

If you understand what the VC wants and you want that too, then you are
aligned. If you don't then you are making a mistake.

~~~
jfoster
That almost gets you there, but founders who misunderstand what VCs want will
still take the investment. That sounds like a nitpick, except that, in my
experience, lots of entrepreneurs misunderstand what VCs want, thinking that 7
- 8 digit exits are what VCs aim for.

~~~
blinduck
I'm very curious. What is it you believe VCs aim for?

~~~
billmalarky
I think he is suggesting VCs want much larger exits than the average founder
(at higher risk). Isn't most of Y combinator's success from just a couple
massive paydays (airbnb and dropbox etc)? Whereas an exit like reddit in the
15 - 20 MM range is considered a big win for the founders, but quite "meh" for
the investors. VCs need big wins to be really successful.

~~~
jfoster
Thanks. That is what I was suggesting.

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andrewchoi
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.

~~~
scootklein
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
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
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
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.

~~~
mbesto
> _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"_

To add to this, the top 10 VC firms make up around 85% of _all_ of the returns
of VC firms combined, and the top 15 VC firms make up around 95%. (don't quote
me on those specific numbers, but I believe they are roughly accurate based on
a report from a16z).

Long story short - very very few VC funds see worthwhile returns. The one's
that do are absolutely killing it.

~~~
exelius
The best VCs have basically created a self-fulfilling prophecy: many of these
firms do well BECAUSE the top VC firms invested in them. If a16z or KPCB
invests in you, it makes it a lot easier to get press and additional rounds of
funding from other VCs because one of the top firms "blessed" you.

------
chiph
_Investors sometimes say mean things about these “lifestyle businesses” but
you don’t have to care what investors think._

There's nothing wrong with a lifestyle business, as long as it's run like a
business. There can be decent exits (purchases by competitors, private equity,
etc). But the employees seldom see a big payoff. In return, you usually get a
pretty comfortable work experience.

~~~
watwut
Employees seldom see a big payoff. Period.

Startups trade salary and benefits now for maybe huge payoff later. The maybe
in previous sentence is important, most startups fail.

Some business are build to stay there, grow and earn enough for founders to
make them upper middle class/rich for the rest of their lives. It is different
then Facebook like success, but most would count that as successful too.

~~~
danieltillett
I have often thought that it would make sense for employees of different
companies to pool any equity. You already take on enough risk being employed
by a startup business without adding on your equity risk too.

~~~
vonnik
That's an amazing idea. What would it take?

~~~
danieltillett
A YC application - lets call it poolr :)

More seriously there is a number of ways of doing this. I would imagine the
simplest would be to create a trust and have everyone give their equity and
options to the trust.

The bigger issue is how to ensure that people don't game the system. The
assets being put into the pool need to be accurately valued so people don't
put in what they know are worthless assets. Of course there is there is the
reverse situation where those already in the pool undervalue new assets.

Most of the effort of this idea needs to go into setting up the rules so that
everyone does the right things and everyones interests are aligned. While I
think this might be hard, I don't see anything that can't be solved by some
smart people.

~~~
bksenior
A simple voting mechanism would work where you announce the shares you own to
the pool you want to join.

~~~
danieltillett
Yes this might work - you could also have a bidding process where you put up
your shares and the various pools can bid on them.

~~~
aamar
Derisking makes economic sense, but incentive stock options are mostly
nontransferable. You're describing a market for shares of a privately held
company, which the SEC doesn't want (except through some very specific
protocols like JOBS Act crowdfunding).

~~~
danieltillett
The stock or stock options aren't really being sold as such, just given to the
pool. I am wondering if the pool members could continue to hold the options,
but enter into a secondary agreement to share any gain with their fellow pool
members. This would be a derivative of some sort I guess.

~~~
msandford
The problem is that when a company goes big and someone gets a good exit they
personally own that money until they make good on their secondary agreement.
It would be easy to rationalize that it was specifically their personal hard
work that helped make the company succeed. And since it's their money they
have a big enough war chest to fight giving it to the pool. Or they can just
skip the country. If the payoff is big enough there are plenty of folks who
wouldn't mind trashing their reputation. And then that's the end of the pool.

Don't get me wrong, it seems like an interesting idea. I would love to have
some way for my un-diversified work portfolio to get diversified. But short of
creating a sweat equity only market/exchange I don't really know how you'd do
it.

Even that has problems because people could fake a startup well enough to gain
access to the returns creating a free-rider problem. It's probably easier to
cook up a bunch of buzz and interest over an orchestrated 3 month campaign
(esp. with a Kickstarter) than to actually do a startup. And since you're
faking it you can promise the world and raise huge money from unsuspecting
dupes with no intention of (much less a plausible method for) making good on
your promises.

------
danieltillett
The most interesting section of this article is the very appropriately named
section "venture math is a harsh mistress". Out of the 1000 companies 188 were
acquired, 28 went bust big time, 8 went public, leaving 80% unaccounted for.
What are all these companies doing?

~~~
danielweber
Worst outcome: just slogging along, not good enough to exit but not bad enough
to kill so people can get on with their lives.

~~~
nmjohn
That's not all bad though, assuming you are successful enough to be pulling in
an equivalent salary to what you could make elsewhere.

~~~
jfoster
Also, if you recognize that it's where you are, you still have the option of
pivoting it into something bigger.

------
bishnu
I found the comments about the derision of lifestyle businesses interesting,
particularly in light of some of the consternation around the Tarsnap price
cut [0]:

[0]:
[https://news.ycombinator.com/item?id=7523953](https://news.ycombinator.com/item?id=7523953)

~~~
danielweber
There's a world of difference between, at one end, taking VC that puts you on
a rocket ride of "get rich or die"; or, at the other end, not taking any money
at all so that you cannot hire even 1 engineer to help you making the
essential backup service into something that's one bus away from losing all my
data.

------
mindcrime
The other issue that didn't come out here, is that venture funds are time
limited by definition. So it's not _just_ that the VC fund wants their
portfolio company to have a big exit, but they want them to have a big exit
_in a specific timeframe_.

This is one thing I like about bootstrapping... the timeframe goals are down
to a combination of what me and my co-founders want, influenced by competitive
issues. But, as it stands, our burn rate is low enough that our "runway" is,
essentially, infinite. Except that's not _completely_ true since we don't live
in a static ecosystem. Other companies are out there advancing tech and making
moves of their own.

But still, I generally like not being bound to a VC and having to deal with
the whole misalignment of objectives issues. We may still raise VC money at
some point, but it'll be if/when conditions clearly mandate it - it's not
something we'd do "just because that's what startups do".

~~~
Gustomaximus
I've seen this time issue with a couple of companies. There hits a point when
the VC wants to exit so they start pushing to shut down areas of a business
that have future potential to maximise the expense/revenue/profit ratios
within their short planned exit window.

------
pushkargaikwad
This is what I have learnt from my experience and what I have seen in Indian
startup ecosystem

1\. VC making money, Company making money and Founders making money are three
different things. Don't get confused between them. Most often, the founder get
the leftover, with big exit, it can be huge amount but not for everyone.

2\. VCs are there to make money. That's it. That is there ONLY goal. Anyone VC
firm who is saying that they are behind entrepreneurs, they are NOT. They are
only after money and the entrepreneur is between them and money. So if your
goal is same as their's, start chasing money.

3\. You will lose your freedom for ever once you raise VC money and along with
it, your choices.

------
tlogan
But there is one important reason why to get VC money: if you have business
model working, VC money will help you (or it is necessary) to hire more people
and generate more revenue.

Now, of course VCs want great returns but they are also ok with ok returns.

~~~
autarch
But did you see the bit about preferred investment shares? An "ok" return may
be ok for the VC, but it could leave the founders and options-holding
employees with very little (or nothing).

Contrast this to a bootstrapped company. In that case, an "ok" return can be
pretty good. If you're bootstrapped and you own 40% of the company, a $5
million sale is pretty great.

------
EGreg
It's interesting how things work out. Since we didn't have the connections at
first, we wound up getting our company to the point where we don't NEED
venture capital to get to where we want to go. We can get there organically.
If we take VC, it will be for a land grab and massive acceleration. So in some
ways, things work out just the way they should if you don't go out of your way
to chase people.

Kind of like how you get married to the right person if you just keep being
yourself.

~~~
cjf4
It baffles me that more startups don't have this approach. If you're going to
take VC, you'd damn well be targeted and have a specific idea of how your
going to use it to grow your business.

------
graycat
The main problem with the OP is that it was looking at broad averages while
necessarily venture capital and ambitious start ups need to be quite
exceptional. The broad averages say next to nothing about the exceptional
cases. In particular, the probability of being exceptional is just irrelevant.
Instead, what is just crucial is the conditional probability of being
exceptional given the details of the specific project. So, it's just crucial
to consider the details of a particular project.

A sad part about venture capital is that it is looking for exceptional
projects, necessarily ones that will in effect push forward the boundary of
computing in our civilization, and doing so with in nearly all cases very poor
qualifications in doing or evaluating such projects.

And venture capital has another problem: Too few projects on the other side of
the table have much potential of such pushing the boundary.

For all concerned, only a tiny fraction of the venture general partners have
any hope at all of evaluating projects that push the boundary.

We should be making much faster progress.

------
redguava
An article on reasons to raise venture capital would be more appropriate. The
default should be bootstrapping.

~~~
wpietri
Oh, the article's definitely appropriate, because right now there are a lot of
people for whom raising money is basically the point.

I mentor sometimes at startup events, and there's a big difference between the
people there to build a business and the people who have been freebasing
startup propaganda. I never thought I'd be nostalgic for the post-bubble
period when startups were unfashionable.

------
bsaul
Wonder if any VC would refuse to invest money in a very promising startup
after realizing the funders are not "aligned" with the VC goals ( providing
the money would give a certain amount of control of course ).

We put the blame on funders for accepting, but maybe offering is to be
considered as well.

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j45
I heard an interesting explanation a while back ago about not seeking venture
capital, and instead seeking an investor.

Investors are more committed and interested (by the explainer) to the
entrepreneur instead of looking for deal flow and exits above all else (which
I guess most VCs are more interested in)

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mandlar
Mirror:
[http://webcache.googleusercontent.com/search?q=cache:http://...](http://webcache.googleusercontent.com/search?q=cache:http://modelviewculture.com/pieces/five-
reasons-not-to-raise-venture-capital)

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mccloy
"2\. Raising venture capital doesn’t make you a good person." Is there anyone
out there trying to raise money because they think it'll make them a good
person?

~~~
velik_m
I think that would be probably better put as "Not raising venture capital
doesn't make you a bad person", but that doesn't sound quite as good.

------
Im_Talking
... because equity is gold.

