
VCs need one large exit to see good profits - prostoalex
https://techcrunch.com/2017/06/01/the-meeting-that-showed-me-the-truth-about-vcs/
======
birken
VC isn't necessarily designed to have returns that are better than the public
markets, only to have returns that are _different_ from the public markets. If
you have billions of dollars to invest, you want to diversify. So the core
part of the message that VC is broken because most of them don't beat the
public markets doesn't really matter.

> One-two years for scouting and finding 10 A-round startups, four-five years
> for growth. Add some non-stop pressure on the founders to sell all the way
> around.

Holy moly. How well would this have worked for Google to sell to Yahoo or
Facebook to sell to Google? You are throwing out the baby with the bathwater
here.

If a company blows up, the vast majority of the returns are coming after 4-5
years. I mean, look at GOOG, and _only_ returns since it went public (~6 years
after founding). Google's stock is up 1700%, the public markets are only up
~150%. You want them to sell those returns to somebody else? And obviously
this post-IPO gain is just a multiplier on the returns from Series A --> IPO
which is just astronomical returns you'd be not getting.

> Invest in more startups/less cash in each.

Just doesn't make sense. For many VCs the limiting factor is their ability to
spend their time and effort trying to help their portfolio companies. Good VCs
don't just give money, they give guidance, advice, strategy, etc. You can do
this with 2-3 companies, not so much with 20-30.

> The ancient “2 percent and 20 percent” should be killed off and replaced
> with something that endorses higher alignment. Let the VCs fight for their
> supper.

What is the suggestion?

~~~
dsr_
Here's an easy one: 20% of profitable returns, without the 2%. If you don't
make the money, you don't get the money.

~~~
birken
How are the VCs going to keep the doors open?

If you take away the 2% return, you've basically said that only super rich
people that can afford not getting paid for 5-10 years should be VCs. Do you
think that all the best investors in the world are super rich people?

Also, when to take that 20% is an issue. Perhaps a VC that is strapped for
cash would push a company to exit sooner, or sell the stock right after the
IPO, so they could take some of their profits off the table and thus get some
working capital. However maybe they'd get a better return for both themselves
and their investors by waiting another 5 years. Sequoia has very famously said
that they've gotten more returns from their companies _post-IPO -- > now_ than
they have from _initial investment -- > IPO_. If you believe in the long term
prospects of a company you essentially want to never sell the stock.

I'm not suggesting there isn't an alternative, but I'd like to see it. The LPs
who continually agree to this fee structure aren't idiots.

~~~
jonwachob91
>If you take away the 2% return, you've basically said that only super rich
people that can afford not getting paid for 5-10 years should be VCs. Do you
think that all the best investors in the world are super rich people?

You can take away the 2% and leave some value value that still pays the
investors. The problem with 2% is that the fund managers often taken home %1
type wages without actually performing. A %1 fee with a clause that caps all
fund managers salaries at $60k (or some livable wage) ensures that the
investors can live, but puts all of the income incentive on their bonuses
which is tied to fund performance.

~~~
jacquesm
> The problem with 2% is that the fund managers often taken home %1 type wages
> without actually performing.

Right, and fund managers will work for free instead. I know quite a few of
them and I would not want to trade with them. Spend half your life in transit
lounges of airports and the other half in hotel rooms, maybe if you're lucky
you get to see your kids on the weekends. I know divorced couples that get
more family time than some of the VCs I work with, they're the hardest working
people that I know, much harder than most founders.

I suspect that your viewpoint is not illuminated with actual experience of the
VC world.

Note that people that made enough money to start a VC fund usually value their
time well and if you want to get them to pull your cart for you (as an LP you
have to do absolutely nothing) they expect to be compensated for their time.

------
tdeck
The Kauffman foundation published a study about venture capital a few years
ago; we read it in my Tech Entrepreneurship class. They reached similar
conclusions:

[http://www.kauffman.org/-/media/kauffman_org/research-
report...](http://www.kauffman.org/-/media/kauffman_org/research-reports-and-
covers/2012/05/we_have_met_the_enemy_and_he_is_us.pdf)

> Venture capital (VC) has delivered poor returns for more than a decade. VC
> returns haven’t significantly outperformed the public market since the late
> 1990s, and, since 1997, less cash has been returned to investors than has
> been invested in VC. Speculation among industry insiders is that the VC
> model is broken, despite occasional high-profile successes like Groupon,
> Zynga, LinkedIn, and Facebook in recent years.

EDIT: This is actually linked from the article but I thought it was worth
calling out nonetheless.

~~~
dxhdr
> despite occasional high-profile successes like Groupon, Zynga

Are those really the definition of a VC success story?

~~~
esm5
The Kaufmann report was published in 2012. At that time, both companies looked
like VC darlings.

~~~
tdeck
It's funny to look back on that now. Only makes the finding that much more
poignant.

------
rlucas
Clickbait title for a naive look at a pretty well-understood, much-scrutinized
topic.

Digging in further:

\- assumptions are bad. 7-8% in RE / public equities? Hmm, dubious.

\- poor understanding of TVM. 12% is 3x? Except, in the real world, there are
incremental cash flows on both capital calls and returns ... so IRR.

\- completely ignores cyclicality. Vintage year is the single biggest
determinant of venture performance.

One big plus: takes a bit of the wind out of the "we VCs are paid to take
risks" strutting. Of course, professional VCs gauge risks and make informed
bets. But as the author points out, it's mostly with other peoples' money.
True. Entrepreneurs are the ones taking the real, personal risks.

~~~
jeo1234
Historical returns on the S&P 500 are about 10%.

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ChuckMcM
It is important to understand that these studies really are looking at the
'post dot com' VC industry or perhaps more succinctly "what it became after
that event."

And it would be wrong to assume that there aren't market forces, working even
as we type, to 'correct' the imbalance. If it had not been for the
exceptionally anemic returns to be had in general, I expect this correction
would have happened sooner.

But unlike startups that post 'incredible journey' type farewells, VC firms
that evaporate are rarely reported on. There are firms which are contractually
following through on their existing funds, raising no new funds, and
entertaining no investments in companies they aren't already invested in.
These are dead venture capital companies that are waiting for the end of life
support.

I am curious what the next chapter will look like. A lot of people think it
will be more 'integrated' VCs that look more like Y-combinator and less like
Sequoia. Hard to say.

------
pcl
The math in the article seems to be based on the assumption that the money
committed for the fund is payed by the LP up-front. My understanding is that
that's typically not the case -- instead, the LPs commit to some dollar
amount, but only actually write checks when the VC round makes an investment.

I haven't done the numbers to see how this changes the outcomes in the
article, but it seems like it probably has a pretty big impact, considering
how much the article focuses on the liquidity aspects. I wonder what the
contribution graph tends to look like over the lifetime of a typical fund.

------
paulpauper
The problem is the market only cares about companies that have the potential
to be the next Tesla, Facebook, amazon, etc., so unless you're in a this very
special and exclusive niche, exiting is very hard. It's not like in the 90's
when all tech sectors did well...now it's just social networking, apps, Tesla,
and Uber. A very lopsided, winner-take-all market.

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HillaryBriss
Nice, clear statement of the fundamental theorem of VC funds: _...the only
realistic way for a fund to get acceptable returns is to try to find only the
companies that could be the next Ubers, Facebooks and Airbnbs. Under these
rules, it doesn’t make sense for VCs to invest in anyone that can’t get to
unicorn stage. There’s just no place for “average” companies..._

~~~
JumpCrisscross
> _There’s just no place for “average” companies_

Sure there is: bank loans, growth capital, corporate backers through a JV, _et
cetera_. This is how new business was financed for centuries. If you're
talking about companies that grow up to be "average" but still fail at the
rate and with the recovery rates of aspiring unicorns, then ofcourse not.

------
mbesto
None of this is "news", just another re-hashing of "yet another explanation of
how VC works, because VC's will never admit their mode plainly". Here ya go:

[https://blog.wealthfront.com/venture-capital-
economics/](https://blog.wealthfront.com/venture-capital-economics/)

[https://blog.wealthfront.com/venture-capital-economics-
part-...](https://blog.wealthfront.com/venture-capital-economics-part-2/)

[https://medium.com/startup-grind/technology-due-diligence-
or...](https://medium.com/startup-grind/technology-due-diligence-or-lack-
thereof-fbeb46687bec)

EDIT: Just re-read, makes sense why this is "news"... " _I recently had a
meeting...talking about the macro view of venture capital and how it doesn’t
actually make sense....It took me a while to understand what this really
means. "_

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tryitnow
> There’s just no place for “average” companies looking to be worth and sell
> less than $500 million. At least not with VCs.

Ummm, yeah, that's right because those investors are called growth equity
investors. They don't get the attention VCs do but they are out there.

~~~
roguecoder
The mythology around VC investing is so intense in the valley it is at the
point where people don't know (or don't have to know) that there are
alternatives that don't rely on massive growth.

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mschuster91
> I’ll clarify: Ninety-five percent of VCs aren’t actually returning enough
> money to justify the risk, fees and illiquidity their investors (LPs) are
> taking on by investing in their funds.

Illiquidity? Well given the huge amount of capital in the markets, there is
next to zero other way to invest your big monies while also wanting some
above-inflation return... the only real exceptions are pennystocks (aka spread
and hope for a unicorn, just without a VC as "middleman"), real estate (which
may or may not crash soon-ish, given that the bubble in Western markets, esp.
London, has been created by Chinese and Russian investors hoping to stash
money away before capital flow regulations) and VC.

Everything other is dead: State bonds, e.g. the German bonds, even pay
negative interest, "conventional" lending is also downhill, and the market is
too short-term-thinking to go long on "classic" stocks.

To summarize: Yes, there is a huge amount of risk and fees involved when
investing with VCs, but they are not creating illiquidity when there's next to
nothing where liquidity can flow into. And only when looking via this
viewpoint one can understand how Yo could get 1.5M $ VC at 10M $ valuation.

~~~
roguecoder
This is the natural consequences of growing income inequality, especially as
fueled by our failure to tax investment income at the same rate as other
income.

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ThrustVectoring
>Invest in more startups/less cash in each. The assumption today is that VCs
want to own 20-25 percent equity of any startup in which they invest, assuming
they have cash to follow up. The reasoning being, if there actually is a
realization event (exit/IPO), they want to score big.

This isn't the reasoning behind it. The actual reasoning is more like
constraints in number of worthwhile investment opportunities.

If the fund has $100M to invest and a hundred startups that meet their
criteria, the fund _has_ to average $1M per investment in order to invest all
the money that they want to. If they have $200M, the average investment has to
go up to $2M.

VCs are already talking to as many companies as they can. Investing in more
opportunities means lowering their standards. Assuming that VCs are rational
about their standards, this is a poor choice.

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dzink
The 2/20 model doesn't go away because it is a signaling mechanism for quality
during fundraising with LPs. A16Z actually raised their carry to 30%. Since
only 1/4 of VC funds actually outperformed the S&P Index in a Kauffman study,
it doesn't pay to advertise yourself as the "cheap" VC.

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elmar
This 4:30m video of Mike Maples explains very simply what VC is all about.

[https://m.youtube.com/watch?v=a5nVkkk2NtA](https://m.youtube.com/watch?v=a5nVkkk2NtA)

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roguecoder
The one problem with this post is the idea that past performance predicts
future results. Do previously-successful VCs actually do better in the future?

