

Why startups don’t die at large hedge funds - cwan
http://jonsteinberg.com/2010/02/startups-dont-die-at-large-hedge-funds/

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rantfoil
The perceived risk vs reward on a tech startup venture vs. playing the markets
is completely different.

In hedge funds, earners get their big juicy paychecks when they prove they are
earners. The methods by which you make money, while varied, are a far more
known set. In general, you're not going to talk to a finance guy about what
he's doing and then walk away thinking they're an idiot. Look at the
scorecard, they must be doing something right.

In tech, the opposite is true. Ideas that seem far-fetched or absurd blossom.
Sure fire hits crumble. Things that seem insane one year become obvious the
next. Startups are incredibly speculative because we're exploring unknown
spaces. But that's why you take the risk and go out there... because nobody
else believes in it as much as you do.

If you add the bureaucracy of a large company to the mix, there are too many
people in the way to say no. To crush the idea and the team before it even
exists. And that's why as founders, we quit.

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pmc255
Agreed. This is one of the areas of business where the MBA graduates of this
century can and should really focus on: restructuring the modern corporation
to allow for proper incentives and encourage innovation. Companies these days
are more internally communist, with top-down centralized command. See
[http://www.salaminder.com/2010/02/large-corporations-
inheren...](http://www.salaminder.com/2010/02/large-corporations-inherently-
communist/)

~~~
plinkplonk
"This is one of the areas of business where the MBA graduates of this century
can and should really focus on: restructuring the modern corporation to allow
for proper incentives and encourage innovation."

MBA grads might be the worst people to attempt this. A typical MBA grad is no
shape to make innovative changes in a corporation.

~~~
krav
Sorry to be harsh about this - but this is borne out of the reality of having
worked with MBAs at startups and huge corporations: If you want innovation,
first step - fire the MBAs.

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ig1
Or maybe you should learn to hire innovative MBAs ? - a lot of stupid MBA
bashing completely ignores the fact that there are a lot of MBAs driving very
successful start-ups and large tech companies. Especially if you look at
business rather than consumer focused start-ups.

There are crappy MBAs just as there are crappy programmers. Thinking that all
programmers are crappy because you've only worked with crappy programmers is a
logical fallacy.

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angelbob
I continue to be amazed that big companies don't do this. The first big tech
company to figure out how to successfully do mini-startups within the company
(with slightly less risk and slightly less reward for the engineers involved)
will sweep all before it until their competitors figure out the trick.

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FreeRadical
Isn't Google a good example of this with 20% time?

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coliveira
No because the reward is small compared to starting a startup. You might be
lucky at Google and get a huge bonus, but it is not the same as having a cut
of the money generated by your product.

~~~
jonsteinberg
Agreed...the system doesn't fully work. This is why people have to leave,
create value, and then sell their companies back i.e. Vark

~~~
fnid2
If Google gave employees even just 20% of profits generated from the products
they build or prototype, that system would fully work for everyone.

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gruseom
Many people (including me) have wondered why large tech companies don't do
this, and many people (including me) have quit and founded startups instead. I
think it must be intrinsically hard to do. Look at it this way: there already
is a mechanism for spawning startups that distinguishes winners and lets
founders reap rewards. It's called the open market. So essentially, for an
organization to succeed at this would mean beating the market. That's hard.

I'm unconvinced by the analogy between hedge fund managers and startups. The
variation in what the former are doing is miniscule compared to the variation
in the latter. That doesn't make it easy to be a winning trader, but it does
make it far easier to identify winning traders and build an organization
around them.

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justin
I don't think the article is exactly right. Young managers stick around at
hedge funds not just because they get incentivized with a percentage of their
returns, but also because it is hard for them to raise sufficient capital to
start their own fund. Most of them would probably prefer to manage that
25-100M in their own fund and take the entire 20% of generated returns instead
of sharing it with the fund. Generally when they have the experience and
contacts to do so they _do_ go out and start their own fund.

Quite the opposite, it doesn't take much capital to start a web company any
more. Consequently, lots of teams of engineers can leave a big company and
build up value on their own with out the support structure (i.e. capital) of a
bigger company. Then they have the freedom to get paid the market value of
their work in an exit, instead of their returns being determined by a single
party (the company they worked for) with no competition.

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j_baker
This is an interesting idea, but I don't think that there's any real
substitute for going out and starting your own company. In any big company (no
matter how good or liberal technology-wise), there's always an element of
inertia. That is to say that there's always a sizable group of people who will
resist change for resisting change's sake.

I simply don't think there's any way to remove that element without leaving
the company altogether.

~~~
marshallp
that's the point of what the op is suggesting - that you grant internal teams
full autonomy

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cperciva
This doesn't always work, though: Jeff Bezos worked for a large hedge fund
(D.E. Shaw) before starting Amazon, and pitched the idea to management -- and
only left to found Amazon on his own when Shaw wasn't interested.

~~~
bd_at_rivenhill
Starting an online commerce firm from inside a hedge fund is not exactly what
this guy is talking about. He's talking about allowing promising managers to
invest money (which is a hedge fund's business) without excessive direct
interference from more senior managers and with a direct stake in the outcome.
D.E. Shaw is not an internet company (Juno aside). What the author is
suggesting would be something like Google giving operational autonomy and a
percentage of the profits to the guys who came up with gmail.

~~~
jonsteinberg
Yes that's what I meant. There is too much top down at all the major tech
companies.

No one tells a pad manager at DE Shaw what to do. He either thrives or blows
himself up and is fired.

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mustpax
I would wager that if you were to aggressively short other traders' portfolios
in your own fund, you'd quickly find that there are limits to the independence
of your pad.

Selling into the same consumer segment is much more cannibalistic than finding
varying arb opportunities in different market segments.

~~~
marshallp
No, the shortedn traders would either wise up quick and change strategy or get
fired.

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gyardley
The value of a money manager at a hedge fund is easier to objectively and
fairly measure than the value of a startup.

Even if an Internet behemoth like Google paid engineers large sums for their
successful 'internal startups', I don't see how they'd come up with the same
value as a competitive acquisition process with the startup retaining the
option to walk away and carry on independently. Entrepreneurs would still
leave in order to avoid being subject to the whims of the one and only one
potential 'acquirer'.

~~~
jonsteinberg
The valuing is tricky, but the M&A groups do it every day.

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DaniFong
This is one reason large tech companies do spin outs, though I am not sure of
any companies that have become overwhelmingly effective at it.

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samd
Rather than the big companies taking the risk of funding many "pads" most of
which will fail they let other people put their money at risk and only end up
buying the proven winners. How much money would they have had to throw at
failed "pads" before getting Aardvark? If the answer is more than $50 million
then they got a good deal.

~~~
jonsteinberg
Thats a fair analysis. I bet its less than $50M. Also there's a lot of wasted
value by not allowing for autonomy. Look at MSFT
[http://www.nytimes.com/2010/02/04/opinion/04brass.html?scp=2...](http://www.nytimes.com/2010/02/04/opinion/04brass.html?scp=2&sq=microsoft&st=cse)

~~~
rortian
You wrote a good post. It reminded me of 'The Origins of Wealth' by
Beinhocker. He spends a lot of time exploring why most companies spend most of
their time playing it safe and why so little is spent on exploring new
markets/business models.

He also makes the point that most companies don't survive very long. I don't
think tech is especially unique in this regard.

People probably don't leave the hedge funds because they are in a great
situation. Hedge funds managers get to play the heads I win tails I get a
management fee game. People, once they have wealth, can be surprisingly risk
averse and don't want to risk substantial portions of their own wealth as
capital in a new venture.

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ahi
In tech companies market position matters. You can't just have everyone
working on their pet project, because they all have to fit together to form a
cohesive unit with adequate positioning and power. Except for the occasional
market manipulation, that's just not true with hedge funds.

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_delirium
Considering the overall poor performance of the hedge-fund managers
compensated in this fashion, isn't this a model _not_ to follow?

~~~
bd_at_rivenhill
I'd actually like to see the citation for the poor performance of hedge fund
managers, or are you just basing this comment on the recent media portrayal?

~~~
_delirium
Here's one analysis, which while not all bad, is not particularly positive
either: <http://www.cfapubs.org/loi/doi/abs/10.2469/faj.v61.n6.2775>

~~~
bd_at_rivenhill
Thanks for pointing this one out. I'm looking forward to a year or two from
now when someone can do a study of hedge fund performance net of fees vs. a
benchmark such as S&P500 over the last 10-20 years including 2008 and 2009. I
would expect hedge funds to outperform, and the last 2 years have been a once-
in-a-generation event to check that hypothesis against.

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ggruschow
"Otherwise we are resigned to this cycle of great tech companies having
relatively short lives compared to industrial counterparts."

What's the problem here? Did I miss the lesson on why we need to create long
lived legal entities? It's not even on my priority list.

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jcnnghm
Of course tech companies don't do this, it's all about risk. Tech startups are
difficult, expensive, and high risk. It takes the right kind of people to
start something successful, most people can't do it. Places like Bell Labs
don't exist anymore predominantly because it's cheaper to let other people
cover the risk, and only buy companies that have a product and significant
traction.

Hedge fund managers don't have a 90% chance of producing something nobody
wants and losing all the money that was invested in them.

