
Losing Money - ghosh
http://avc.com/2016/04/losing-money/?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+AVc+%28A+VC%29
======
tedmiston
Peter Thiel in _Zero to One_ :

> The biggest secret in venture capital is that the best investment in a
> successful fund equals or outperforms the entire rest of the fund combined.

> This implies two very strange rules for VCs. First, only invest in companies
> that have the potential to return the value of the entire fund. This is a
> scary rule, because it eliminates the vast majority of possible investments.
> (Even quite successful companies usually succeed on a more humble scale.)
> This leads to rule number two: because rule number one is so restrictive,
> there can’t be any other rules.

~~~
dean
> only invest in companies that have the potential to return the value of the
> entire fund

I have a feeling this is much, much easier said than done. How do you even
determine "potential" of a startup, when, according to Paul Graham, "the best
ideas look initially like bad ideas".

~~~
skewart
It's incredibly hard to identify successful companies early on. But following
Thiel's rule isn't actually all that hard.

The key is to look at the total addressible market for a company or product.
It has to be large, or growing quickly, or both. For example, AirBnB might
have looked like a bad idea, but the hospitality market is huge, so if it did
work out then they could grow to become a giant company. On the other hand,
you could create a transformative product for blind people, and build a
business around it that makes you a multi-millionaire. But VCs will never
invest in your company because there just isn't a big enough market. You might
3x or 5x an investment but you'll never deliver the kinds of giant returns VCs
need in order to make their LPs happy.

Of course, I'm talking about traditional VC firms - like the one the blog
post's author runs. There are all kinds of investors out there with different
motivations.

~~~
addicted
When Facebook came around, wouldnt the addressable market have looked tiny?
Basically US based college campuses.

Or was Zuckerberg already envisioning opening it up and spreading it far
beyond college (and maybe high school) campuses?

~~~
mahyarm
Another thing about startups I've realized is you want to start with something
small, but you could also see being expanded further.

For example, snapchat started with LA teenagers. Facebook started with
harvard, then ivy league colleges, etc. Uber was licenced black car services
in SF only at first, etc.

~~~
tedmiston
Always.

And it's funny - the startups that try to start with "we're revolutionizing
the world" end up over-promising. The ones like you mentioned actually do. Not
only just in starting in one market, but focusing on one customer segment, or
one feature, or one vertical.

------
db1
I raised a small seed round (200k) on my first company. At that time I felt
like it was a staggering amount of money. The company didn't work and out we
pretty much lost all of it. For the longest time, I felt really guilty about
how I had lost my investors money.

I have a little more perspective now and realize that it was practically
insignificant to my investor.

Ah well.

~~~
brianwawok
Honestly I think it is good to feel guilty. If you felt 0 guilt and just
shrugged, I think it would make you seem a little bit of a irresponsible
sociopath.

Now obviously don't live in a basement for 6 months because of your sadness,
it was an investment that they could afford to lose ;) But I think it normal /
expected to feel sad/guilty when you let someone down...

~~~
tsunamifury
They gambled and lost. As long as you weren't funneling the money into your
own account or fraudulently representing yourself you have absolutely nothing
to feel guilty about.

~~~
morgante
I see where brianwawok is coming from. You shouldn't feel an overwhelming
sense of guilt, but you also still let people down.

Also keep in mind that most entrepreneurs raise some very early money from
individuals ("friends and family") who _don 't_ have portfolios with dozens of
companies.

~~~
Scirra_Tom
> but you also still let people down

This isn't true in my opinion. (Unless you didn't do what you said you'd do).

------
habosa
Can someone help me do some math here? Take these sentences:

"It was all about five investments in which we made 115x, 82x, 68x, 30x, and
21x."

"In our 2004 fund, we invested a total of $50mm out of $120mm of total
investment in our nine losers. "

OK so in the 2004 fund we have $70mm being invested in companies with rates of
return between 21x and 115x. Let's be conservative and say the total return on
that $70mm was 50x. That means 70mm --> 3.5B. If we assume that's the total
return on the fund we get 120mm --> 3.5B.

I am now going to assume these returns were realized over a period of 10
years. So that works out to about 40% gains each year (compounded 10 times).

Is USV really making 40% every year for a decade? Are other VCs doing that
well? I knew these funds were good investments but I didn't realize just how
good.

~~~
jimminy
He also says they invested in 21 companies in the 2004 batch. Which means that
7 other companies returned negligible results.

Average investment per company was about $5mm.

So we can end up with:

$5mm * 115 = $575mm $5mm * 82 = $410mm $5mm * 68 = $340mm $5mm * 30 = $150mm
$5mm * 21 = $105mm Total: $1.58B, about $1.5B after losses.

So that comes out toabout a 27% return, using the same math as you, before
costs and management fees.

~~~
stupandaus
The final results are public information via UTIMCO, so no backdoor
calculations are necessary: [https://www.scribd.com/doc/277150709/UTIMCO-
PrivateMarkets](https://www.scribd.com/doc/277150709/UTIMCO-PrivateMarkets)

UTIMCO invested $22.25m and was returned $280m in cash with $33m still active
in investments, resulting in a cash-on-cash return of 12.57x and a 66.7% IRR
(after fees).

Overall fund size was $125m, so $1.57b cash-on-cash returns for the fund after
fees, assuming no LP tiered returns

------
nostrademons
This can also be a good rule of thumb for entrepreneurs investing in ideas or
potential new features, or even for ordinary employees managing their careers.

You can get surprisingly far in life simply by cutting your losses early. If
you majored in art history, got to junior year, and then suddenly realized
there are no jobs available - switch your major! Or transfer, if you have to.
If you hate your job, find another one! If your skillset is out of date, learn
whatever the new hotness is. If you picked a dead-end field that's being
disrupted by a new industry, switch to the new industry.

Many people _don 't_ do this, because of a couple of cognitive biases: sunk
cost fallacy and fear of the unknown. But they ignore that they've learned new
information in whatever their old role was, and that the future is usually
much longer than the past.

~~~
dgant
Plus
[https://en.wikipedia.org/wiki/Effort_justification](https://en.wikipedia.org/wiki/Effort_justification)

------
karterk
This also explains why VCs look to fund billion dollar opportunities even if
they look a little risky. VCs are in the game for big exits and that's how the
math works out.

Something to keep in mind when you're planning to raise money.

~~~
90002
I think entrepreneurs often forget that VC's are deploying OPM, which puts an
enormous amount of pressure on the firm to deliver outsized returns. I've met
a few entrepreneurs over the years that fail to understand this fully - sad!

~~~
tedmiston
Other People's Money

Ah.

[http://www.bmecapital.com/Common_Practices.html](http://www.bmecapital.com/Common_Practices.html)

------
colinbartlett
It would be awesome to see a list of the winning companies and the approximate
multiple on invested capital returned for each of them, along with which
companies fizzled out.

Not expecting to ever see that, but it would be interesting to learn which
ones they thought would be huge successes and what the eventuality was.

~~~
eastdakota
USV's 2004 fund invested in Twitter, Tumblr, Indeed, Etsy, and Zynga. Those
likely represent the 5 double-digit return multiples Fred references. It was
an astonishingly good fund — certainly among the best of its vintage and
perhaps among the best of all time.

~~~
vram22
Indeed.com sold for around $1 billion, or so I heard from a startup founder
that I did some consulting work for (he was in the recruitment space too, and
had a prior exit or two). Later googled for that info and saw links that
looked like it was true. A Japanese company recruiter.com bought it.
Interestingly, I don't remember reading about the Indeed sale on Fred's blog,
though I've been reading it for some years now. Could have missed the post, or
could be he never wrote about it.

Edit: grammar.

~~~
mikeyouse
[http://avc.com/2012/09/indeed/](http://avc.com/2012/09/indeed/)

> _Indeed has always been the quiet one. Nobody really talks about them. But
> as I have said a number of times on this blog, they are the most complete
> company in our portfolio. They have it all. Two world class entrepreneurs as
> founders. A solid management team all up and down the company. A product
> that is beloved and services more than 80mm people worldwide every month. An
> engineering team that has kept the service up with literally no down time
> that I can ever remember. A business model that, like Google 's, is the best
> on the Internet. Revenues, profits, customer satisfaction, shareholder
> value. They built a fortress and I am just so happy to have had a front row
> seat watching them build it._

~~~
vram22
Also, just saw at the AVC link you posted, this:

[http://avc.com/2012/09/indeed/#comment-662213687](http://avc.com/2012/09/indeed/#comment-662213687)

Indeed used Lucene.

------
tedmiston
Is there a technical meaning when he refers to fund years as "2008 vintage"
vs. just "2008"?

~~~
joncrocks
Not beyond what you'd probably assume it to mean...
[http://www.investopedia.com/terms/v/vintage_year.asp](http://www.investopedia.com/terms/v/vintage_year.asp)

~~~
tedmiston
So, the idea: is "compare this fund against others that were started in
economic conditions like 2008", _not_ say 2006 or 2012. Does that seem right?

~~~
taylorwc
Yes exactly. Like cohort analysis for venture funds. Compare them to peers
that had experienced the same macro trends and conditions.

------
xpda
It's risk/reward. Whether a VC fund, NYSE, or government security, you can
risk more for greater reward. This does not mean, as the article implies, that
you should. It depends on the individual and the purpose of the investment. I
can probably make a lot more money investing in a riskier company, but I am
also more likely to lose some or all of my investment.

If I am considering investment in a fund that expects a 40% annual return, I
should remind myself that if it was a sure bet, then enough people would be
investing in it to drive the price up and the return down. There are plenty of
investors as smart as me, and many of them are willing to do more research
than I am.

------
elmar
The Babe Ruth Effect in Venture Capital

[http://cdixon.org/2015/06/07/the-babe-ruth-effect-in-
venture...](http://cdixon.org/2015/06/07/the-babe-ruth-effect-in-venture-
capital/)

------
baccredited
I'll summarize: Many startups fail. Don’t throw good money after bad.

------
sakri
Why does he use mm ($25mm)?

~~~
bryanlarsen
'M' is the roman numeral for thousand, so 25m traditionally means 25000. mm is
thousand thousand, aka million.

~~~
zeeZ
And SI uses 'M' as a prefix for one million. Oxford defines 'm' as million(s)
in a money context, Merriam-Webster includes 'M' as an abbreviation of
million.

It seems odd that anyone would think $25m should be read as $25000. It's much
more likely that I would read $25mm as 25 millimeters instead.

~~~
bryanlarsen
The problem is that there are multiple traditional usages, with overlapping
meanings.

Capital M has traditionally stood for both thousand and million. In other
words $20M and $20m is ambiguous, depending on what tradition you come from.
$20MM and $20MM and $20k are not ambiguous.

------
hackaflocka
> I am a big believer in “loving your losers” in the sense that you should not
> orphan them and you should work hard to get to the right outcome.

From the guy who talked about cutting off losers early a paragraph ago.

------
paulpauper
My 'fantasy VC' scorecard since 2008 is nearly perfect, having hypothetically
put money into snapchat, air BNB, Uber, and Facebook. Picking the future
winners from the losers seems very easy, but the problem is if everyone did
this strategy many companies would go unfunded. Just simply funding companies
that are already big and growing rapidly and riding the momentum, seems to
guarantee the most consistent returns. Investing in tiny startups seems not
worth it since the expected value is not high enough and the liquidity is
probably poor.

~~~
beachstartup
_> Just simply funding companies that are already big and growing rapidly and
riding the momentum, seems to guarantee the most consistent returns_

if you ever try raising money, you'll find this is pretty much what 99% of
money people do. and they'll say it to your face, because what are you going
to do about it? beg harder?

it's a bullshit job, to be honest. anyone with decent intelligence and basic
social skills could do it. that's why they guard the industry tooth and nail.

i'm no yc fanboy but in my opinion that's what makes them "the 1%", they
actually invest in risky startups, en masse. i try to picture some of the
vc/pe firms i've talked to doing this, and it doesn't even compute.

------
greenspot
Nice write-up, would have loved to know how your current fund performs and who
are the losers now.

~~~
tedmiston
Unless you are currently one of those "loser" companies...

------
sz4kerto
Note: Ben Graham wrote about all these decades ago. (It doesn't make this
article less true, etc. -- just if you're interested in these basic rules of
investing, then read 'The Intelligent Investor'.)

~~~
ghshephard
I thought Ben Graham, and the Intelligent Investor, was the absolute
antithesis of high risk Venture Capital.

From the introduction to that book:

"Our text is directed to investors as distinguished from speculators, and our
first task will be to clarify and emphasize this now all but forgotten
distinction. We may say at the outset that this is not a “how to make a
million” book. "

and

" “An investment operation is one which, upon thorough analysis promises
safety of principal and an adequate return. Operations not meeting these
requirements are speculative.”"

Fred Wilson is in a very, very different space then Ban Graham was discussing
in the Intelligent Investor.

~~~
dbcurtis
They are both speculators, just different time horizon.

My epiphany came when a few years ago I had a conversation with a friend who
is a brewmeister and restaurant manager for properties owned by his family's
trust. (If you live on the Peninsula, you have probably had his beer.) His
grandfather had set up a trust in order to pass his Monterey-area produce farm
to his children, and the trust and farm are still going, and growing. My
friend mentioned he was spending the weekend at a family retreat with some of
his siblings and cousins that were the current trust management. The topic for
the retreat was identifying which of "the cousins" (the pre-teen and teenage
children of the next generation) were likely to be future manager-trustees,
and which were likely to be passive trustees. The goal being to start
identifying and grooming the next generation of management.

So my definition of investor: If you are managing the asset with the intention
that someday your as-yet unborn grandchildren will be taking over and managing
the asset, you are an investor. All else is speculation, just on various time
horizons. An investor is _never_ looking for liquidity, ever -- only
speculators expect to turn an asset into cash in the foreseeable future.

~~~
ghshephard
How do you define liquidity? If there is no way to take your investment, and
turn it into liquid cash in the form of a stock sale, or dividend, then what
is the purpose of said entity? Sounds more like a foundation with some broader
goal (societal, religious, environment, etc...) than a financial investment to
me.

~~~
dbcurtis
Ahhh... we have discovered a True Speculator :)

If sale of the asset is the only way your asset returns cash to you, then it
is certainly speculation by my above definition. Have you not considered
operating a business as an on-going entity producing profits on a regular
basis? Or have you become so blinded by the VC model that you can't imagine
doing anything other than selling your stock to the greater fool? I can assure
you that my friend's brewery produces liquidity in the form of cash as well as
libations. Well, the latter turns into the former, to be most precise.

It is striking that actual operating profits have become such an insignificant
part of the asset valuation process that some people forget the existence
thereof.

~~~
ghshephard
What purpose are profits if you don't liquidate them? Unless you are Scrooge
McDuck and you just enjoy diving into vaults of moola. (not sure if I'm dating
myself with that reference)

------
homero
Good thing he's got bitcoin to fall back on when the vc bubble pops

------
dataker
Why would anyone feel guilty about losing money from a VC?

In the end, it's a venture capital FUND: risk and return are inherent to this.
It's not the VC's money, but a collection of GPs (themselves have thousands of
individual investors).

Your loss is already accounted for in their portfolio. Otherwise, they're not
doing it right.

~~~
taylorwc
Have you ever taken money from outside investors? It doesn't really matter
whether the investor expects loss or at least is aware of the risk. Losing
other people's money when they took a bet on you is a miserable feeling. Add
it on to the list of things that can keep you awake at night when you're a
founder or startup exec.

~~~
dataker
No I haven't, but I have money on companies.

Many things can happen (disease, conflict, competition,etc) and I surely won't
make a founder feel terrible about himself because of that.

Instead, I pick someone with a different personality, industry and network
that is able to balance my risk.

~~~
taylorwc
I applaud that you would never try to make a founder feel terrible
intentionally. That said, most founders end up struggling with those feelings
regardless. It's an awful feeling, even if you know your investors understand
that there is huge risk and don't demand a guaranteed home run (not that there
is such a thing).

