

The Unsaid Reason VCs May Not Back You: Resource Efficiency - markpeterdavis
http://www.markpeterdavis.com/getventure/2009/03/the-unsaid-reason-vcs-may-not-back-you-resource-efficiency.html

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tptacek
This is really just a long way of saying that services companies get lower
multiples (1.5x-2x) than product companies.

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kurtosis
Okay, what he says sounds plausible - I guess consulting is an example of a
business with linear "resource efficiency". But he doesn't explain the _faster
than linear_ resource efficiency case very well. The obvious answer is a case
where you get x% more customers per unit time then your effort on your product
produces x% more value. Okay, so how do VC's identify businesses that will
have X% growth in the number of users? Inform please.

Also, just a pedantic gripe, but someone should really inform this guy of the
meaning of exponential growth. His definition that an "exponentially" growing
firm the next million nets more value than the previous million would also
apply to quadratic growth.

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ojbyrne
I'm sure he'd look at you blankly if you tried to tell him that. Innumeracy is
embraced by business people. They made "All I Really Need to Know I Learned in
Kindergarten" a best-seller.

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chiffonade
> Innumeracy is embraced by business people

A good businessman uses his numerical intuition far more than his numerical
literacy - math is a way to prove intuition as it relates to business.

A good mathematician also operates in this way - a proof starts out as
intuition. People with poor business/social/numerical intuition often point to
this as a flaw, but it's really an advantage. That's why the best engineers
eventually end up as business people. Look at the partner roster and board
members of any top flight VC firm in the valley - a high proportion of them
are former engineers.

You're not going to find many former accountants or statisticians in the
bunch.

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djahng
I think VCs in general will be backing less companies in the next year or two.
Part of this may be that limited partners who have pledged a certain amount of
investment capital will be trying to delay VC funding rounds until the economy
stabilizes. Other has to do with the fact that there was a drastic reduction
in IPO and M&A activity in 2008. In 2007, there were 86 venture-backed IPOs.
In 2008, there were only 6, and 5 of those were in Q1 2008. On the M&A side,
there were 360 venture-backed M&As in 2007. In 2008, there were 260. So in
other words, VCs aren't getting their money back.

Out of the less number of companies being backed, I guess by this article's
argument, these "exponential growth" companies are more likely to be funded.
But isn't that obvious? If you were going to invest your money, would you
invest in a company that "grows slowly" or a company that "grows really fast"?
I guess it's safe to say: don't try to start a venture-backed service
company...

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ccarpenterg
Build/Make/Do it once, sell it many times. However, fixed costs (non
continuous function) increase as customers increse in numbers. Consumer
products have variable costs ($/unit) and a non continuous function for fixed
costs too. At full capacity you have to build more physical capacity
(investment + fixed costs) in order to supply more customers.

So trying to find out what this Mark is talking about, you can think the value
added as a function that is trying to scape toward the infinite (in the
y-axis). Web based services has no variable cost (or this is tiny) so value
added is pulling down only by fixed cost, which at some point jump to other
value (we have to increase capacity to continue serving current and new
customers!). It seems that web-based services value added function can reach
farther points. This makes sense on a paper but real business is harder.

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paul_houle
There a lot of people chasing the kind of opportunities that he advocates:
ones that have strongly superlinear scaling. That kind of investment comes
with a possibility of an explosive gain, but there are many opportunities out
there that are profitable but don't grow quite as dramatically. If investors
didn't put money into them, they'd be (i) leaving money on the table and (ii)
impoverishing the development of a wide range of goods and services that
people want and need.

