
How VCs Make Money - zigzaggy
https://vcstarterkit.substack.com/p/how-vcs-make-money
======
H8crilA
One thing that you have to keep in mind is that the 20% part is effectively a
European call option on the fund's portfolio, with strike equal to the fund's
initial value (so ATM - At The Money - when the fund starts) and notional
amount of 20% of the fund's value. The manager gets that option for free, in
fact he's paid 2% a year to hold that long option (and do his/hers job). Call
options are more valuable if the underlying security is more volatile (because
there's higher chance of ending in the money), which of course encourages high
risk taking.

This is all not necessarily bad, but the incentives are not to be ignored. VCs
have absolutely zero interest in stable businesses (remember - they _want_ the
volatility). If you're a stable business you would want a value investor who
keeps close to 100% of his net worth in his fund, like Warren Buffet or Seth
Klarman to give two famous names.

~~~
woah
It’s strange how often people need to be reminded on here that VCs invest in
businesses that grow fast or fail. There’s a vocal contingent on here that
feel it’s some kind of moral failing and are mad that nobody is getting
excited about their bingo card creating website.

~~~
csa
> There’s a vocal contingent on here that feel it’s some kind of moral failing
> and are mad that nobody is getting excited about their bingo card creating
> website.

LOL. I hope this is HN /s. If so, it has several layers of humor.

The guy who actually created a bingo card creation site has been fairly vocal
with his stance that VC money should only be taken for rocket-ship trajectory
businesses — with bingo card creation and other businesses he ran not being of
that ilk.

IIRC, people have tried to get him on the VC track with a different business
to no avail (yet).

Additionally, he (informally?) advises people who are applying to YC, and I
think one point he consistently brings up with founders is whether they are
sure that their business even wants to go on the VC path/trajectory. I think
that’s a great question that many people don’t stop to ask due to the
pejorative “lifestyle business” label ( _cough_ that might have a high chance
of increasing ones net worth by millions rather than billions _cough_ ).

Regardless, to confirm and reiterate your point, VCs aren’t looking for
singles... their looking for home runs, and they don’t mind striking out while
pursuing that goal. If you take VC money, fully expect to be pushed to those
extremes.

~~~
hef19898
Funding a company is hard. I'm bootstrapping and funding will become a key
issue in the next couple of months. My preferred solution is a classical bank
loan, maybe backed up by some of the available government-sponsored programs.
Why? Because while I maybe could frame my business in some VC-friendly way and
go out pitching it I don't want to give up more control than absolutely
necessary. Also, I am perfectly fine to have a well running mid-sized business
one day (if luck will have it). VCs are not, and being forced to go for 20x+
exit can only mean one huge acquisition or an IPO. Not my cup of tea.

Also, every minute I pitch a VC is minute I cannot pitch actually paying
customers. I get that some businesses need a lot of money to come up with a
product and thus need VCs. I'm lucky to not need that amount of money and to
finance the whole product development myself for the next couple of months.

But I can't stop wondering if it would be possible for VCs to buolzd a
portfolio of profitable, cash positive mid-sized businesses to find the more
adventurous investments.

~~~
csa
Assuming that this is a business that has some sort of online component (esp.
payments), consider Stripe — they offer loans based on cash flow history with
their service.

I’m not sure what level of cash you need, but this might do the trick without
giving up equity or control.

Not affiliated with stripe — just a fan.

~~~
hef19898
Thanks for the tip, certainly will take a look, could be very helpful in case
I sell stuff myself. Which also needs a lot more capital.

Does stripe also have a B2B / invoicing functionality?

~~~
clintonb
Yes. Stripe Billing ([https://stripe.com/billing](https://stripe.com/billing))
supports recurring invoicing (e.g. subscriptions) and non-recurring invoices.

~~~
hef19898
Cool! Will definitely have a look at it!

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motohagiography
Wow, what a great post.

The most interesting question for me is, if you are a company with VC money
and they are on your board, does the age of the vintage of the fund the money
came from impact the strategy of the company down to a product level?

It looks like you could literally calculate/estimate the time left in the fund
and see how much pressure it will put on the CEO to get positioned for an
exit, then predict that impact on product, and the entire culture of the
company.

e.g. "we're an engineering driven company," vs. "the fund that gave us the
money has 2-3 years left in it, which means all our product decisions are
based on getting positioned for a forced exit, so create tech debt and STFU."

~~~
alpha_squared
If I understood the post correctly, fresh investments typically happen at the
beginning of the fund. Only half of investable money is invested so that
follow-on investments could be made when those portfolio companies go to raise
again. It seems like the pressure might be on you, as a startup founder, if
your vintage is underperforming and the fund is nearing the end of its
expected return. Others in the vintage may have even had an easier time
exiting, even if modestly, because they weren't encumbered with the pressure
of carrying the vintage -- if that makes sense -- since they wouldn't be
around near the expected return date.

~~~
mdorazio
That's the "Investment Period" quoted in the tweet. In the example it's 4-5
years, which means the fund needs to do its initial investments in 4-5 years
from the fund start date. If you're in the later portion of this window,
you're effectively going to get less time to build your business before the
firm is pushing you to exit or looking to abdicate/write you off.

------
refrigerator
Brilliant post — very informative + clearly written.

> What goes unsaid, is that only the actual partners in the fund get any
> carry, associates just get a comfortable salary and the prospects of
> becoming a partner (at another firm obviously)

"(at another firm obviously)" — I've heard this in other discussions about VC
careers too. Why is it the case?

~~~
harveyesq
Because it takes 10 or more years for one fund to run its course. If the
associate stays with the VC firm, it's a long uphill road rising to the top.
The fastest shortcut is to jump over to another firm that needs that
associate's skillsets, and might even be open to issuing a profit's interest
(split off of carry).

~~~
refrigerator
How come they need to wait til the whole fund to run its course before
bringing on new partners? Don't they raise new funds every few years, before
old ones have entirely exited?

~~~
harveyesq
Yes but the average partner per fund for microVC (under $100M) is less than 2
people (1.94 is the average). So unless you're working for a large VC platform
with several funds and plenty of room on the team's cap table, you're waiting
patiently on the sidelines of a very long game.

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ninkendo
This article needs to define its terms. What is a GP? Sure I can google it but
this is supposed to be an article that explains that kind of thing, I may as
well just google how VCs make money and read a different article.

~~~
harveyesq
GP = General partner;

LP = Limited partner

GPs are the VCs, the ones wearing Patagonia puffer jackets. LPs are the actual
investors, including pensions, endowments, sovereign wealth funds, high net
worth individuals, and on occasion, larger institutionals like hedge funds and
publicly traded corporations.

------
imgyuri
For those who don't know, their website
[https://vcstarterkit.com/](https://vcstarterkit.com/) is pretty amusing as
well.

~~~
jordanpg
Missing only a complementary headset with a little yellow foam ball on the
mike so that, as a legendary, venerated VC, with zippered vest and arms
outstretched, you can stand on a dazzling, shiny stage and impart your
profound wisdom to the enraptured audience before you.

------
Roritharr
I've sometimes wondered if transitioning from CTO to VC makes sense/is
possible, has anyone tried that?

~~~
superhuzza
Paul Graham essentially went this route, no?

~~~
sjg007
YC, effectively, owns the whole stack (i.e. vertical). Their main selling
point is the YC network and being founder friendly to derisk creating
startups. YC also created the continuity fund that is where the typical VC
comparison would be. I am not sure what the terms on it are but I imagine it
is geared only to their companies. This means YC is willing to assume more
risk and gives a vote of confidence for their products. It's amazing really to
see this grow as big as it has in 15 years give or take.

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xorfish
So if 2/3 of the funds income is from the management fee, wouldn't that mean
that the average VC fund clearly underperforms the market?

~~~
notfromhere
There was a Kaiser(? maybe someone else) that over a 20-30 year period, most
VCs don't return capital.

Your average VC fund absolutely underperforms, and even the "good" funds
sometimes just get lucky and run with that until the good will runs out.
Andreessen's 2010-11 funds have underperformed the market.

~~~
WooShoa
I find it interesting when people make a fundamental miscalculation like you
did. They perform EXCEPTIONALLY well … when you start understanding who they
are performing for.

Gold rush … something, something … shovels.

But I know. I know. I speak heresy on this site. I repent and beg for
forgiveness for saying the kind has no clothes on.

~~~
notfromhere
They're great for the VCs who want to harvest management fees, but not-great
for the institutions who put their cash in.

The real question is: as a society should we give 2/20 to people who spend
most of their time wasting time on twitter and quoting Sapiens to each other?

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chewz
> How VCs Make Money

A: They don't. VCs are an asset class that generally is loosing money
(liquidity adjusted). So do not put your money into VC.

[] [https://finnscave.com/2016/12/13/venture-capital-cash-
return...](https://finnscave.com/2016/12/13/venture-capital-cash-returns-v-
stocks-and-bonds/)

------
pipogld
I hate acronyms. I hate them even more when I found them in articles with no
reference about what they stand for. Just one reference at the beginning of
the text would suffice. That should be a rule in writing articles. Without it,
it makes it more difficult to learn something new and it makes the whole text
losing intellectual integrity.

~~~
Bootwizard
You are reading a news site run by a Venture Capital company. I feel like you
should know what VC means.

~~~
posedge
He is probably referring to GP and LP, which are not explained in the text. I
found that annoying as well.

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flashjpr
> Do you need $200M to operate a twenty person firm for four years and to keep
> the lights on to make follow on investments for the next six years? Not
> really.

What a joke. Ofc you do. Like all satire aside, that's a middle-class
statement.

