

98% of VCs Aren’t Dumb - ssclafani
http://www.bothsidesofthetable.com/2013/05/25/as-populist-as-it-may-feel-98-of-vcs-arent-dumb/

======
mindcrime
This reminds me of an exchange from a few weeks ago
(<https://news.ycombinator.com/item?id=5500592>)

Somebody said:

 _As a former investor, an entrepreneur that thinks he/she understands my
business better than I do is a big red flag._

and I replied:

 _As an entrepreneur, an investor that thinks he/she understands my business
better than I do is a big red flag._

To me, this gets to (or near) the heart of the thing. If you're a VC / angel,
you're probably fairly smart, probably well connected, and probably have a
modest amount of interesting experience in many things. But if you're not one
of the VC / angel types who came _from_ a background as an entrepreneur, why
should I believe that you have much knowledge that will be _specifically_
relevant to my business. And why should I think you are particularly well
suited to judge my business?

msuster, sgblank, pg, and a few others, I would put a lot of faith in, based
on their backgrounds... but most other VCs, I really wouldn't be looking to
them for much besides: A. money and B. introductions / referrals. I almost
certainly wouldn't be looking for product advice or marketing strategy, etc.
from them (unless they had some proven background in that area).

~~~
tptacek
One reason is because, operational experience or not, VC partners all sit on
the boards of companies, most of which fail, and so have a front-row seat for
their implosions.

~~~
mindcrime
Fair enough.

I still have my doubts about how much the gain from that experience, that will
lend value to any _specific_ future potential investment, unless the firm that
failed was in a very similar business. And you also have to consider that VCs
frequently sit on multiple boards, and have routine "vc firm dealflow" stuff
to deal with, so their attention gets spread around a lot.

Anyway, I don't mean to say that they don't have anything of value to add. But
I will stand by saying "you claiming to be an expert in my business is a red-
flag", barring some specific evidence to the contrary.

------
rayiner
I felt Dunn's post missed two things:

1) The 2% who make most of the returns is not consistent from year to year.

2) A VC who underperforms the market isn't a loser, because he's still
collecting his paycheck (maybe with a smaller bonus than otherwise).

The combination of 1 and 2 is why the "98%" can keep raising capital, and is
the open secret of the professional investment management industry. You can
see the same trends in say hedge funds or other actively managed investment
funds.

~~~
rdl
In VC there are 5-10 funds, universally known, who are the winners, and who
continue to win. They get the best dealflow, meddle the least, and generally
are on top.

The crazy thing is that KPCB used to be in that set and then essentially
voluntarily abdicated to do cleantech crap.

A16Z came from nowhere to join that set pretty much as they launched.

The others (greylock, sequoia, benchmark, accel, etc) are pretty static.

~~~
rayiner
Note the distinction between some funds being consistent winners, and the
whole set of winners being consistent over time. The 5-10 funds who are
consistent performers: 1) aren't the whole of the "2%" who manage to make
above-market returns over some time frame; 2) can't absorb all the money
investors want to put into the venture capital as an asset class. That keeps
the other VC firms who aren't Sequoia, etc, in business, even if the generated
returns are less than stellar. That does not mean, however, that the other VCs
are "losers." They still get their 2 and 20, and as long as everyone is
consistently mediocre and the top VC funds can't absorb all the capital the
big institutional investors have sloshing around, they'll keep being able to
raise capital.

Interesting (and fairly recent) analysis of VCs from the point of view of a
limited partner with investments in a range of VC firms:
[http://www.kauffman.org/uploadedFiles/vc-enemy-is-us-
report....](http://www.kauffman.org/uploadedFiles/vc-enemy-is-us-report.pdf).

The mediocre return of VCs also says something about Silicon Valley. The idea
of venture-capital funded startups as some exceptional economic engine is
probably a myth. There is a lot of economic activity in Silicon Valley, no
doubt, but you have to distinguish between expenditure of capital and return
on capital. $20 million spent on a startup that never ends up making much
revenue is not a net gain to the economy even if it shows up as economic
activity. It's just expenditure of capital. So the success of specific VCs
aside, the way to measure the economic contribution of VC-funded startups is
by looking at the return on investment of the sector as a whole. And since
that return isn't great, relative to blue-chip companies, that tells us one of
two things about the sector:

Either: 1) VCs aren't great at the job of allocating capital to the right
places; or 2) VCs are doing the best job they can, and its just inherently
difficult to separate the winners from the losers when it comes to startups.

My gut feeling is that the answer is (2), which implies that the nature of the
industry is such that it's so hard to separate the winners from the losers
that the gain from the exceptional success of the winners is largely offset by
the cost of funding the losers, which makes the economic returns from the
industry as a whole unexceptional compared to the returns from traditional
blue chip companies.

~~~
rdl
Presumably part of the low return of VC is due to declining marginal returns
due to too much money.

If SF VC funding were somehow constrained to $1b/yr, you'd get crazy
percentage returns, since either only the top deals would get funded, or
they'd be funded at super-favorable valuations (allowing more deals on the
same money).

~~~
rayiner
Well that's true in any sector. Returns go up when capital is scarce. But SF
with $1b/year in VC funding would be economically insignificant, even if the
returns were great.

~~~
rdl
I guess my real point is that if my choice as an LP were a16z or some other
asset class, I'd maybe even slightly overweight vc as an asset class. If I
were an LP who could get into YC (maybe they would take a non profit like
Watsi if they raise an endowment?), obviously overweight. But if you couldn't
get into a top fund, and didn't personally know the founders of a 30-50mm fund
which you thought would do exceptionally well (500 Startups?), I'd underweight
or just avoid the asset class.

~~~
rayiner
I don't disagree with you. If I were CALPERS and needed to throw around money
$5 billion at a time for it to be worthwhile, I might avoid VC entirely. My
point is more about what it says about the industry as a whole. Total Silicon
Valley VC investment is in the neighborhood of $11-12 billion/year. If the
rate of return on that relatively small investment is, on the whole, less than
the S&P 500, then that really calls into question the whole narrative about
how much economic value is really being generated from VC-funded startups.
Blue-chip companies might not be able to yield Facebook-like returns, but they
can apparently yield VC fund-like returns, and do so while absorbing far more
capital.

~~~
rdl
I'd like to see the IPO market re-open, and companies IPO around when they'd
be doing large Series B today, or certainly anything after a B.

Seed and maybe A are not capital intensive, and are probably constrained by
great ideas, founding teams, and early entrepreneurial employees. But I don't
think VC is the right way to finance lower risk later stage stuff; the public
markets could do a good job, and it would be a lot easier for risk-seeking
investors (individuals or institutions) to get in and out of investments vs.
being LPs in funds, and with lower overhead.

~~~
hga
I don't think any analysis of post-SarBox VC returns can be useful without
examining the effects of the closing of the IPO exit. Sure, a very few, very
exceptional companies can take this route, but it has otherwise been shut
after a good 4 decade or so run.

~~~
rdl
In addition to lowering returns, it unfairly prevents smart but non-rich
individual investors from investing in awesome opportunities like Tesla or
SpaceX in 2008.

~~~
hga
Hmmm? The Dodd-Frank Act as of July 21, 2010 excluded an accredited investor's
primary residence in counting their wealth (although for many I'm sure that
was closing the barn door after the house's value plummeted), but I don't
remember anything like that in SarBox (the accredited investor restriction
goes back to 1933, thank you FDR).

~~~
rdl
I meant that SarBox defers IPOs until stupidly late, so "normal" investors,
reliant on the protections of the public market, don't get to invest early
enough to make real money.

~~~
hga
I'd adver that "stupidly late" really is now "never", with rare exceptions
that prove the rule like Facebook---which was mispriced but otherwise doesn't
deserve its bad reputation (their IPO, not the company), and that's going to
further dampen tech IPOs going forward for some time. Why was it mispriced??

Turn it around, to cash out, is your objective an IPO or acquisition by
another company?

Further, the sharp decrease in VC returns means less in the pockets of
founders and early employees, and therefore less smart money in the game.
Heck, you mentioned Elon Musk's Tesla and SpaceX, his money to get them going
comes from PayPal, which was bought by eBay in 2002 (by then it was already
getting very bad---granted, that was when the dot.com and post/911 crash was
playing out---but SarBox is generally viewed as the last nail in the coffin).

~~~
rdl
Yes. I suspect the next 5-10 years will see one of:

1) Big non-US market growing up (probably in Asia, but possibly in
cypherspace), with more rational regulations

2) Massive slowdown in tech progress (which one might argue is underway, but
not as obvious; if it accelerates, it will be obvious)

3) Some way for PE to take over from public markets. Content to sit on
revenue-generating companies throwing off cash. This already seems to be
happening; I'm not sure what the tax consequences are, but I suspect they're
smart/powerful enough to either financial engineer or politically engineer a
solution.

All of them suck for different seasons. #2 is probably the worst for me
personally.

------
justinbeaver
Dear dumb entrepreneurs who want to raise VC: bootstrap instead. VC forces you
into a 'go big or go home' strategy. There's nothing wrong with going big, but
just do it the patient, more sustainable way. And then you never need to worry
about the points made in these articles. You just get to sit back and laugh at
them while you're owning and running your own business.

P.s. there is a time and place where big time capital is necessary to start
but most of those businesses aren't reading HN.

~~~
mindcrime
_There's nothing wrong with going big, but just do it the patient, more
sustainable way. And then you never need to worry about the points made in
these articles. You just get to sit back and laugh at them while you're owning
and running your own business._

This is our mindset. We definitely plan to be big (real big) but we're patient
and we don't have to paint ourselves into a corner or take any bad deals by
trying to do it all at once.

That's not to say that it wouldn't be _nice_ to have more capital to work
with, and that's not even to say that we won't _ever_ take VC money. But if we
do take VC money, the goal is to do it when we are well positioned to get more
favorable terms.

~~~
justinbeaver
Agreed on the growth capital point completely. Was referring specifically to
early stage capital in my comment - should have been clearer. Thanks.

------
tyang
VCs are quite smart.

Where else can you charge 2 and 20 for long-term returns below the far less
risky small cap index funds?

[http://www.kauffman.org/uploadedFiles/vc-enemy-is-us-
report....](http://www.kauffman.org/uploadedFiles/vc-enemy-is-us-report.pdf)

------
niyogi
The irony of this blog post is that it's very existence proves that the 98%
routinely behave (and believe) they are the 2%.

The other important point is that the 2/98 split is largely exaggerated but
you could make it 10/90 and the point would remain valid.

It's sad that all VCs want to be "entrepreneur-friendly" publicly (largely to
widen dealflow) but are largely the opposite behind closed doors.

------
late2part
Yeah, you have to be pretty smart to convince pension funds to give you money
in an area that underperforms the S&P.

------
ivankirigin
This is the first article I've read that mentioned what the typical return on
a fund is. I have had educated guesses, but why don't we see this broadcast
more broadly. Is it that only LPs care?

I'd generally prefer to get investment from people whose judgement has proven
they know how to get a good return on an investment, because founders
typically get the same "return" from that stage on.

------
dyno12345
They're not stupid. VCs make more money than entrepreneurs do in the long run.

~~~
josh2600
VCs yes; a better question is LPs or GPs. The answer matters greatly.

------
tyang
A friend and fellow ex-Wall Streeter notes:

"All hedge funds are smart. Period. End of story. Whenever you can gamble with
other people's money and get paid on the wins and eat none of the losses,
that's the real win. Anything after that is gravy."

[edited in honor of grammar nazis]

------
wellboy
For me, the 98% of VCs are all like Gandalf the Grey. They have kind of an
idea what they are doing, they maybe actually understand 98% of investment,
but they just can't get the last 2%. The thing is, they are all followers:
Never would they be able to recognize the next Facebook, because it doesn't
fit their pattern, whereas their pattern matching has to look out for startups
that don't fit their pattern.

How do you become a 2% VC? You have to have been a successful startup founder
before. Otherwise, you just don't have the understanding of building the
future. The 98% VCs got there from studying business to working at McKinsey,
to being an Investment Analyist. Yeah they can do fine by investing in proven
startups, that have been done before, but they'll never get their 50x-100x,
because they can't predict the future.

So if you haven't been a founder before and you want to be a VC, please quit
your job, stop wasting everybody's time and money, start a company, and come
back as Gandalf the White.

------
blazespin
Maybe not 98% of all VCs, but I do wonder about 98% of VCs who weren't
successful entrepreneurs at some point.

------
jeffehobbs
What about the 2% of investors that are Dave McClure?

------
michaelochurch
The problem with VCs is not that they're dumb. I'm a pretty severe VC-istan
critic and I would never say that lack of IQ is their problem.

Their problem is that they're ill-equipped to make the judgments necessary to
solve half the problem. They know business and acquisition structures and
legal pitfalls, but in order to really get signal on the judgment of people--
I'm ignoring the judgment of ideas because I don't think anyone has that
down-- they need to hire someone like me to vet technical choices, talent
strategy, culture, etc. because an iPhone app is not going to give them that
kind of data.

How do you find that kind of person if you're not that kind of person? I think
it's almost impossible. How are they going to tell the people like me from the
many who claim they are? Likewise, I'd be incapable of vetting them for
whether they're good at their jobs for the exact same reason. I'm not superior
to them in any way; we just excel at different things and it's very hard for
one side to judge the other.

Perhaps the best way to start a venture fund is to have the selection made not
by permanent VCs judging "the team" but by top-notch programmers who do the
vetting part-time (no more than 10 hours per week). That way, they don't lose
their technical touch and can tell based on technical choices whether a
company has a future. (How would a VC know that a company running a typical
enterprise Java stack is doomed? It's not his job.)

By the way, the reason VC-istan sucks is not that VCs are evil or stupid
people, because they're not. It's that humans are bad judges of character and
VCs are no exception. When you can't judge expertise (and they can't evaluate
technical expertise) you miss out on the associated proof-of-work and default
to social polish, which means that you're going from a slightly positive
correlation to what really matters (character) to a slightly negative one. VC-
istan generates some awful startups, but not because VCs are bad people.

~~~
rdl
VCs already do this.

0) VCs with technical/operating background. I'd put a lot of faith in e.g.
pmarca's evaluation of a team. 1) EIRs 2) Outside advisors 3) Portfolio
companies (you do some pre-screening, then have your existing portfolio CEOs
meet with the founders of non-competitive new ventures. It's win/win, because
the portfolio companies may have some useful business relationship, or if the
founders can't raise, might be a good hire.

~~~
michaelochurch
They're not doing it successfully. They could be.

They pick advisors who know how to do what they already know how to do, to
validate their decisions. That leads to some improvement in the process, but
they're not picking people who _complement_ their skill sets. They're picking
less shiny versions of themselves.

~~~
rdl
The funds where I know EIRs and VPs with tech experience don't really fall
into that; there are absolutely funds which are horrible and have horrible
portfolio execs, eirs, and advisors, but I think if you talk to the really top
ones, you'd be surprised by the quality of talent. The weakness is that a lot
of funds can't/don't hyper-specialize in specific technology, but for instance
there's a VC who has made a lot of security investments who has l0pht people
on the team.

~~~
michaelochurch
Are you suggesting that someone like me should become EIR?

I've seen the quality of people who get EIR roles. They're not slouches, but I
could do better than most of them, and that includes the ones at top firms. I
can actually detect things like what kind of programmers your tech stack will
attract; non-technical executives are better with general-purpose marketing,
but the 10X factor with regard to programming talent is black-magic to them.

Even rarer than 10X programmers are people with enough experience and insight
to know what brings "10X" into being and what smothers it. It's not just about
the people; conditions and configuration play a gigantic role.

I've avoided exploring the VC route (as in, becoming one) because I want to
keep my technical skills intact. Also, I'd be +5 sigma great at one part of it
(evaluating technical choices and judging talent) but I have no idea if I'd be
any good at the other (also critical) aspects of the business. I also feel
like if I committed full-time to nontechnical stuff, I'd lose that +5 sigma
edge. Right now, I know that if you're using Clojure and your competition is
setting up the Java/Maven/IDE environment, you'll almost certainly win. I
might not be able to pick that sort of thing out, in 20 years, if I step away
from using technology on a day-to-day basis.

Right now, I could grep a codebase and tell you better than almost anyone out
there if a company has the technical mettle it needs. ("Visitor" or
"AbstractFactory" = bad, "mapcat" or "flatMap" = good.) I wouldn't have that
if I sat out of the technical game for 20 years, because the signs and terms
would be different.

~~~
rdl
Honestly, I think you're too bitter/pessimistic, even if more than
sufficiently technically competent, to be an effective EIR (or VC/angel, or
founder of a VC-funded company), at least now. But you probably recognize that
:)

But yes, a less-bitter version of you might be a good EIR, although I think it
usually comes from "founder of a company funded by the firm has a midsize
exit", not out of the blue.

Three of my friends were EIRs, and two are now founders of great companies
(although not hardcore tech companies). The other has run off to Spain for a
while, after ~15 years of doing startups, for something of a sabbatical.
They're all at the "code for days straight", graduated from top engineering
programs (in contexts like being in India or ~20 years ago where that
mattered, unlike the US today), etc.

The whole point of EIR is that it's revolving door -- you do it for a year or
two, then go back to startups. It's both a way to take a break, and get
exposed to new stuff. You still use some of your tech skills, and often end up
working on side projects, so I don't think a year off is going to kill your
technical competence.

As for the quality of portfolio company review/advice: one top one sent me to
do an interview/etc. with probably the _best_ operating executive in the
security industry, one of their portfolio companies. I learned a lot, and
decided we should hold off on raising as a result (this was ~2 years ago,
about a month after I finished YC).

Being an actual full-time VC probably does hurt your technical skills, and I
don't think having _just_ fairly narrow programming or programming tech skills
is a useful background for a VC, although "ability to pick winning teams" is
essentially the definition of a successful accelerator or seed stage investor
(but, on more axes than just "can program well"). Something a bit broader and
maybe less deep is good, although in cleantech having postdoc level expertise
might make sense. I think I have more than enough security industry experience
to be an effective security vc, but not enough in the programming tools space,
and somewhere in the middle on deployment/automation/networking tools.

I've talked to VC Principals/Venture Partners who are what I'd consider top-50
domain experts in specific things (payment regulations), and some Partners who
are top-500 on networking or certain parts of security.

The other thing is it's usually better to have domain expertise in the
founding team than implementation perfection, so at seed, a PHP hacked
together piece of crap that works is probably fine, as long as what they're
doing 1) has a market 2) is possible. At Series A, they should probably have
some competence in the team, and after, sure.

~~~
michaelochurch
_Honestly, I think you're too bitter/pessimistic, even if more than
sufficiently technically competent, to be an effective EIR (or VC/angel, or
founder of a VC-funded company), at least now._

I actually think that a bit of so-called "depressive realism" is in order.
Sure, it needs to be tempered with some optimism, but you need at least one
guy with the winter-traveler insight and the courage to say, "Groupon for cat
food sounds like a terrible idea!" Sadly, people like us are not well-received
because we tend to haul out the truth when it's not wanted.

 _But yes, a less-bitter version of you might be a good EIR, although I think
it usually comes from "founder of a company funded by the firm has a midsize
exit", not out of the blue._

So you have to be born into the club to have that option? Not surprising.

Like I said, the future's not going to come from the people born into VC
connections. I don't know where it's going to start and when, but I'm
optimistic enough to believe that Real Technology is coming back. I see it
already, but not in the high cost-of-living areas.

~~~
rdl
"Born into the club" is probably overstating it.

"Pay your dues", perhaps, but competent person -> funded (or employee at
funded company, or just someone known for doing something awesome) -> EIR,
could be 2-4 years.

VCs are probably less stupid about credentials than e.g. Google under Mayer
with the "core schools" crap. Maybe less stupid than "core schools" in
admittance. I suspect being a Thiel fellowship person, a core developer on a
really popular open source project (nginx dude for sure, probably Ver if he
wanted to do something in bitcoin on his own, etc.) would be more than
adequate. Or YC/500 Startups/etc.

~~~
michaelochurch
I don't think that being an employee at a funded company gets a person
_anything_. Companies don't just let engineers have investor contact. The one
case I saw where an engineer got investor contact was someone who was so
unethical and incompetent that he got his mentor (the CTO) fired. (This was
that startup from hell that I worked at in the winter of 2011-12. Initials
TSS.)

You basically have to play degenerate political games to get investor contact
as an _employee_ of a funded startup. It really is a two-class world these
days.

My experience is based on what I've seen in New York, but everything I've
heard about the Valley is that it's the same. Well-connected douches will
always have a competitive advantage over real people. We get our shot when
tech becomes uncool/nerdy again and those assholes go back to whatever douche
Valhalla they return to.

~~~
rdl
That's different from my experience in Silicon Valley, although I've never
worked in NYC. As an employee at a post-Series A company in an industry I knew
approximately fuck-all about (Internet advertising for Facebook), the CEO
introduced me (and other engineers) to VC partners and press whenever they
visited, and if I'd had anything interesting to talk to them at the time,
could have (and that same guy is happy to introduce me to people now, years
later). This was at a ~25 person company. I could see it being less common at
a 400 person company, but probably _more_ common at a 5-10 person company.

I've seen other companies with a variety of weirdly dysfunctional ways of
treating employees, but what's the Tolstoy quote? "Happy families are all
alike; every unhappy family is unhappy in its own way." If you have a decent
network in Silicon Valley, and/or are willing/able to bounce once a situation
seems bad, it's pretty easy to stay in "Happy families" only.

~~~
michaelochurch
It sounds like you met a lot of good people. Unfortunately, the bad kind seem
more common, at least from where I'm standing.

I don't think Silicon Valley vs. New York has a lot to do with it.

The problem is that when you run into bad people and they ruin your career or
steal your future, then good people don't want anything to do with you (or, at
least, have you at arms' length, and that gets annoying) so you get a string
of more bad people (who are always happy to take advantage of your weakened
position).

~~~
blader
Maybe the good people would be a bit less likely to keep you at arm's length
if you didn't come off as assuming by default that founders and VCs are out to
get you, which is pretty annoying and self destructive.

