

The VC Model, The Funded, and The Problem With Associates - BrandonWatson
http://www.manyniches.com/entrepreneurs/the-vc-model-the-funded-and-the-problem-with-associates/

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alanthonyc
"Go build something people want."

I love this post. Although I have no experience with VC's, what he is
describing is a phenomenon I see all the time in my everyday life. I work in
IT and there is no shortage of people who have some "great idea" but are
unwilling to put in any effort to build it out. They would prefer getting
somebody else to do the work for them. Unfortunately for them, the "techie
guys" who can actually do the work know the raw deal they would be getting.

The big difference between these run-of-the-mill idea guys and VC is basically
the size of their wallet. However, the entitlement (read "lazy") mentality
remains the same.

I've even noticed this same phenomenon among some non-IT friends who think
that if they could just come up with some brilliant idea, they could retire
rich. They would just need somebody else to do the work for them once they
found their idea.

~~~
BrandonWatson
You bring up a very interesting point, and one of my top rules of things not
to do if you want to avoid failing. Don't sit around on the couch talking
about the startup you are going to do "someday." People come up with too many
excuses _not_ to do something (economy, finances, wife, kids, etc). It's much
easier to talk about the way things conspired against you, than to put your
nuts on the table and risk failure.

~~~
sutro
I once tried putting my nuts on the table during a pitch to some VCs. It
didn't work out so well.

~~~
BrandonWatson
I once told a VC (after they intimated that they wanted to replace me as CEO)
that it felt like they gave me a nutpunch. The VC didn't understand the
phrase, and I actually had to explain it. Years later, it's how they greet me
- "hey, nutpuncher!"

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donaldc
The 2% per-year annual management fee for vc funds makes me think of the 6%
real estate commission. They both seem arbitrary, archaic, and ultimately
doomed.

~~~
BrandonWatson
The difference is (and I can already feel the flames coming on this one) any
idiot can get their real estate license, so the supply of agents can
eventually impact that number. Forming a fund is prohibitively expensive
(legal fees), never mind actually convincing someone to give you their money.
There's some protections that are afforded by that supply imbalance. The issue
is further exacerbated by the fact that the hot deals go to the "best" firms,
which allows them to prop up their performance...that's not necessarily true
with house sales.

~~~
donaldc
I'm not in any way meaning to imply that real estate agent and vc partner have
similar competency requirements or barriers to entry. Rather, I'm implying
that the fees of both are now highly out of sync with the current reality,
where neither listing houses nor getting startup investment capital are as
under the control of these middlemen as they used to be.

Furthermore, in both cases the fees bear no relation to the value-added
provided by the real estate agent or the vc partner on the particular deals
they make. This is the aspect that feels especially archaic to me.

~~~
netsp
What exactly do you mean by value added?

How do you think they should price their services?

At least with VC's (as opposed to index funds or others) the cost of investing
rises with the amount investing. They can't double their position in their
portfolio if their investors suddenly doubled. They would need to go out and
invest in more companies.

~~~
donaldc
The value added by the VCs is the amount of money the venture capital fund
makes above and beyond what one would make from investing the same amount of
money, over the same time period, in something low/no risk like, say, U.S.
Treasury bonds. If a venture fund does poorly, the value added may be
negative.

VC's should get a significant percentage of their value added. But 2% of the
principle per year works out, over a ten-year period, to a good 20% of the
principle, risk free. That sort of guaranteed return is sure to attract all
the wrong sorts of people to be VCs.

~~~
netsp
The protection against that should be consumer choice.

~~~
donaldc
In theory, yes. And in the great-great-grandparent of this comment, I'm
essentially saying that I feel that the days are numbered for the 2% per year
management fee.

But equilibrium often takes some time to re-establish itself. After a
situation changes, customs take time to catch up with the new reality. At the
moment, it looks like the common practice of VC fees is lagging behind where
it will wind up.

Also, I think part of the problem is that the people making the decisions (the
"consumers" of VC value-added, i.e. large endowments, pension funds, banks,
etc.) generally also have no skin in the game. This means they have much less
incentive to press for the absolute best deal they can get, common practice be
damned, than they would were they investing their own money into these VC
funds. This means that the change in common practice will take longer than it
would were the consumers generally investing their own money.

