
The Quickest Way to Understand VC - ivankirigin
http://blog.yesgraph.com/understand-vc-powerlaws/
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saosebastiao
I had a very brief internship in college with a second tier VC that was
affiliated with a well known sand hill firm. I was only there for a few months
so I saw only a tiny peek at the industry, but it was enough to see through
all the bullshit.

With the exception of a handful of partners at a handful of firms (nothing but
respect for a16z here), they are all complete dunces, and they don't have the
slightest clue what they are doing. This article is right that they are going
for the biggest possible outcomes, but it misses out on the largest and most
exploitable quirk of the VC industry: that they're all chickenshit. They wont
invest unless someone else does, thereby validating their decision to invest.

The most effective cold pitch I've ever seen at our fund involved what was to
me a completely obvious lie about outside interest. I met the guy after I left
and he basically confirmed that he pulled the same stunt at all three of the
firms that invested. He worked them in rotation, building actual interest off
of what was initially fake interest. And it worked like a charm.

~~~
tim333
>complete dunces

You've probably got to be quite bright academically to get in but if you look
at how their compensation works they mostly get a cushy job with a high salary
paid for by a 2%/year or so charge on funds invested. Performance fees on exit
are years away. So if they can say to investors "we're in all the hot starups
like color.com" it works if the investors throw in billions even if the
startups are disasters. So they may be dunces at understanding startups but
are probably quite good at their core business of fund raising.

~~~
ivankirigin
Fundraising for funds is actually pretty hard. Founders that do it tell me
it's harder than fundraising for your startup because LPs are stodgy.

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ivankirigin
Sometimes I hear: "VCs are so dumb! My startup is profitable, why won't they
invest?!"

No, you just don't understand VCs.

VC is not for everyone btw -- profitable business are amazing.

~~~
te
> "They aren’t looking for a guaranteed $1M, they want a _chance_ at $1B or
> $100B. This is really weird, because software business that are profitable
> might not be fundable."

Huh. Sounds like an inefficiency on the funding side. Or is it that these
biz's profitability typically enable self-funding? Why does a profitable
startup that doesn't have VC-style growth potential need funding?

~~~
corysama
Imagine your business was making a solid $1m/year in profit. But, if you had a
one-time cash injection of $10m, there's a good chance you could expand to
$5m/year in just 2 years. That's a risky but potentially profitable investment
that is not interesting to big name VCs. It is an inefficiency on their part.
But, their schedules are already overfull juggling the moonshots. I expect
there are people working in that space, but they don't get a lot of press
coverage.

~~~
ivankirigin
My point with the "involuntary" aspect is that if you had this thesis, you'd
still get power law returns. I'm not sure this has been pushed as hard as it
could be, but this is very consistent feedback from VCs.

And my personal experience of investing.

~~~
corysama
> you'd still get power law returns.

Yep. My scenario was told from the POV of an individual company. That's not a
good way to explain the behavior of investors deciding between companies.

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atemerev
An immediate corollary: only pursue VC funding if you are either: a) rich, and
you don't care about money, but you do care about making a dent in the world;
or b) young, and you don't care (yet) about money, but you want a very slight
chance of going into the big leagues. Being both rich and young also helps a
lot.

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lkozma
In my work I often use the Vapnik-Chervonenkis dimension. Whenever I see
titles such as this, I hope for a moment for some interesting technical
content, only to find that it is about a different VC :)

[https://en.wikipedia.org/wiki/VC_dimension](https://en.wikipedia.org/wiki/VC_dimension)

~~~
IvanDenisovich
I gotta know where VC dimension is used in the real world.

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wtvanhest
Anyone from the music or movie industry care to compare VC to your business? I
figure most big studios are also operating under the power rule, but I haven't
spent a lot of time researching it.

~~~
jonnathanson
I come from the film and TV world. Pretty much the same way of thinking
applies to projects in that space -- with a key difference being that the
projects there are usually zero-sum. Only one TV network can win the bid on a
hot property. So you end up with insane bidding wars on pitches, scripts, and
projects that get hot.

Film is sometimes slightly different, in that two or more studios can co-
finance a film and share in distribution profits (though this occurs through
convoluted means, and for all intents and purposes, there is usually a clear
winner among the herd).

Ultimately, however, the same power law usually applies. One hit is often said
to cover the cost of 10 or more failures, and then some. (Of course, the
converse is sometimes true: one massive failure can tank a studio's year, and
occasionally even a studio.)

I'll tell you this much: Disney doesn't give half a shit about any and all box
office failures in fiscal 2015 when "The Force Awakens" made $920M+ at the
domestic box office, to say nothing of its billion+ more overseas and untold
billions in merch. And on any given year, if it had the choice, it would much
rather have one hypothetical "Force Awakens" and a handful of flops than, say,
a better average return per movie without an outsized monster hit.

~~~
erichocean
Confirmed. (I'm also from Film and Television.)

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jgalt212
Because most (if not all VC's) base their investment decisions on the power
law, I'd argue most entrepreneurs (other than the ones looking to disrupt the
world and all of God's creatures) would be better served by pursuing PE
funding. This crowd has A. a longer term view and B. a bell curve of
expectations on investment returns.

~~~
jonnathanson
Or family offices, which are becoming increasingly popular sources of
financing for startups who either don't want to go the VC route or don't feel
they'd be a good fit at a given stage.

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pizza
[https://en.wikipedia.org/wiki/Jensen's_inequality](https://en.wikipedia.org/wiki/Jensen's_inequality)

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sparkzilla
Shorter: FOMO

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newjersey
Off topic side note to mobile readers on Firefox on Android

If the social bar in the left bothers you, consider enabling the social third
part filters in ublock Origin's dashboard by going to Firefox menu > addons >>
ublock Origin >>> dashboard >>>> third party filters

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andrewvijay
"They aren’t looking for a guaranteed $1M, they want a _chance_ at $1B or
$100B" \- in other words they are greedier than the greedy.

~~~
themartorana
I don't know about that... When you're a VC, you're likely already financially
stable. So you have more flexibility in having fun playing the game. Why fund
a lightly-profitable boring company when you can have a seat at the table of a
company moving or defining entire markets?

~~~
patio11
You should understand that VCs do not invest their own money but rather invest
the money of "general partners" \-- universities, pension funds, wealthy
families, etc. Those investors are sophisticated and have very large
portfolios relative to the amount of money they have allocated to VC (as an
asset class). To gain access to their money, the VC had to both put on a song-
and-dance about how they were going to get returns which were uncorrelated
with the larger market (and huge) and then execute a series of contracts which
constrains the VC's ability to do anything outside of the investment strategy
which they've agreed upon.

It's not just a matter of "swinging for the fences makes me feel more
fulfilled." It is "I have promised Yale that I will swing for the fences or
I'll receive a call from their attorney asking politely for their $20 million
back, and that call will be polite exactly once."

~~~
harryh
s/general partners/limited partners

