
How VC Works – A Beginner's Guide - simonpure
https://simplanations.substack.com/p/2-how-vc-works-a-beginners-guide
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boffinism
This is great. I'd love to see more on how the basic VC model, described
admirably here, contributes to the weird dynamics of the startup ecosystem.

E.g. if the fund size is large enough, VC partners can do very well ($
millions a year) purely from the fee. So they are incentivised to close large
funds, and for that they need to demonstrate _potential_ , which is easiest to
achieve through huge valuations on paper for their portfolio rather than
actual exits.

Like, I'd love to see some relatively impartial analysis of stuff like that,
because mostly the only people who talk about it are ranting.

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vivekraju93
Hey, thanks! I am the author of this. I am certainly thinking of writing about
such dynamics. Also want to cover how lead investor dynamic plays out which
leads to due diligence being passed on/skipped and other signalling stuff.
Still struggling with the structuring of the piece though

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jashmenn
Even though a lot of engineers want to raise VC (or work for companies that
have) the incentives are weird and it can influence your work/job in ways you
might not expect.

When you take VC, you're given millions of dollars to build something huge,
but it's also a Faustian bargain because you're limiting your range of
outcomes.

You might grow a nice, profitable business, but if you can't 100x (or 1000x)
their investment, your investors will be unhappy.

shameless self-plug: I just interviewed Sumukh Sridhara (AngelList Engineer,
@vcstarterkit on Twitter) about VC from a programmers perspective on our
podcast [1] and he's really, really good. If you're a dev looking to learn
more about this, give it a listen.

[1]: [https://podcast.newline.co/episodes/a-software-engineers-
gui...](https://podcast.newline.co/episodes/a-software-engineers-guide-to-
venture-capital-with-angellist-engineer-sumukh-sridhara)

~~~
xmot7
The return profile depends a lot on the stage of VC you're at - while a 100x
return might be plausible for an early angel investor (who also expects 90% of
their investments to go to zero), lots of later stage VC's will be quite happy
with the more consistent 5x outcome.

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mindfulplay
Quote: "Being a VC is fing hard".

But what he won't tell you is much much harder to be a founder/engineer who
actually does stuff.

It's not clear how different this is from say hedge fund? I would imagine it's
the same set of people who just found a nice, easy alternative?

~~~
jordanpg
I think the word "hard" is a bit overloaded in this thread.

Yes, I'm sure VCs "work hard" in the sense of putting in lots of hours or
doing demanding work, but really, who cares about that. Lots of people, up and
down the socio-economic spectrum work hard in this sense. It's not a helpful
distinction. And I'm not impressed by hard work in this sense.

I have often wondered what it is, exactly, that VCs and executives and SVPs
and bankers do that makes their services so valuable and so venerated. As I
already mentioned, it's obviously not just because they are physically
"working so hard." To me it's equally obvious that it's not because they are
incredibly smart or wise. I assert with great confidence that (as a general
rule) truly smart people are not wasting their time with work that is in any
way associated with the movements of small green pieces of paper.

I believe that what is meant by "working hard" in the context of this set is a
certain willingness to make deals or sales at all costs. By wisdom is meant
intuition and connections or a rolodex (ie. the ability to get certain people
on the phone).

But I know this for sure: _something isn 't hard if there aren't any real
consequences for failing_. And in the United States, if you are lucky enough
to clear certain bars, you are exempt from failure. "Failure" and "hard" in
this post means not closing a certain deal, but it doesn't mean anything like
financial ruin. It means a minor roadbump, perhaps some professional
embarrassment, and then onto the next money thing.

This is why I think these people are so utterly unworthy of the fawning
adulation paid to them by SV folks desperately wanting to be rich, suckling at
the teat, fantasizing about someday standing on that shiny stage with the
little yellow ball mic, arms outstretched, telling everyone about their
fantastic vision in broken sentences.

~~~
bhupy
> truly smart people are not wasting their time with work that is in any way
> associated with the movements of small green pieces of paper.

What you call "movement of small green pieces of paper", others might call
"resource allocation", which is a pivotal function in civilization-building.

~~~
jordanpg
I don't disagree, but I maintain that it isn't something that most of the best
and brightest spend a lot of time thinking about.

The fact that the acquisition of lots of money is an end in and of itself
pursued by a class of skilled "elite" white collar workers (like VCs) is
basically a side effect of the "resource allocation" you mention run amok
coupled with faulty wiring in our monkey brains.

~~~
bhupy
Acquisition of lots of money is not the same as moving money around, which was
your original point.

Acquisition of lots of money is also a proxy for impact — if you provide just
$3 of value to every American, ONE TIME, congrats, you're a billionaire.

Hell, there are 7.8 billion people in the world. If you can get 1% of them to
pay you a penny once a year, you're making $780k/year.

Most smart people spend a lot of time thinking about _building empires_.
Making money is just a really nice side effect of building the empires.

In this world, there are 2 endeavors that make a LOT of money: empire building
and macro resource allocation. The majority of the best and brightest will
spend a lot of time thinking about those two endeavors no matter what the
underlying system is. In a parallel universe where all resource allocation and
production is driven by the government — your elite class will simply be in
the officer ranks of those bureaucracies. It's no different from the military
where the elite West Point graduates enjoy greater status than the enlisted
rank-and-file.

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Havoc
Nice explanation. The LP and GP parts feel a little wonky though

>they don't run the VC firm (hence the term 'limited').

It’s from the concept of limited legal liability more than who runs it.

Same for GP - generally just a legal shell. practically it doesn’t really do
the stuff the article implies. The actual running of it is usually in a third
entity (again to separate legal liability). And the carry sometimes goes to a
fourth.

~~~
rmrfstar
[1] is a good resource.

[1] [https://www.amazon.com/Mastering-Private-Equity-
Transformati...](https://www.amazon.com/Mastering-Private-Equity-
Transformation-
Investments/dp/1119327970/ref=sr_1_1?dchild=1&keywords=mastering+private+equity&qid=1590501034&sr=8-1)

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tasuki
> VCs are expected to generate a 25-35% annualized return compared to the
> 12-15% that public equity markets generate and much higher than the 8-10%
> return that debt markets give.

What does "expected to generate a 25-35% annualized return" mean here? Is that
the mean/average annualized return of a VC fund? Or the "wished for"
annualized return?

~~~
xmot7
It's a very aspirational target. 25% annualized return (after fees) is a top
decile fund. I've heard that number as a target before, but rarely and from
investors that weren't used to the market. 12-15% from public markets is a top
quartile hedge fund, still a great return but a little less aggressive than
the VC number.

~~~
pbk1
Under this definition, it would seem as if Andreesen Horowitz is not anywhere
close to a top decile fund[1]. Does anyone know which ones are? Data on VC
returns seems hard to come by.

[1] [https://www.theinformation.com/articles/andreessen-
horowitz-...](https://www.theinformation.com/articles/andreessen-horowitz-
returns-slip-according-to-internal-data)

~~~
xmot7
For industry wide statistics, something like
[https://www.cambridgeassociates.com/wp-
content/uploads/2018/...](https://www.cambridgeassociates.com/wp-
content/uploads/2018/05/WEB-2017-Q4-USVC-Benchmark-Book.pdf) is pretty good.
All returns there are gross, not net, but they show top quartile funds
returning 15-20% gross over the last decade, varying a bit year to year.

For specific fund performance, I don't know of anything public. Most of the
big names have had some funds with >20% returns, usually as they get bigger
those get harder to maintain.

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l8rpeace
Naive question: does this same paradigm apply to angel investing?

~~~
vivekraju93
Not really. A major difference is an Angel invests his own money, not someone
else's like a VC does. So the incentives are different. The angel also sources
deals differently and invests only in very early-stage companies (mostly at
idea stage), so the risk-return picture is even more skewed.

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MarcellusDrum
I hate it when blogs do this. Does it hurt to put the full word in the title
(or at least first paragraph) instead of the initials? It took me a relatively
long time to understand what the article is about when I was reading it.

I don't know about you, but Venture Capital is _not_ the first term I think of
when I hear VC.

~~~
travisjungroth
What is the first thing you think of? The only other thing I can think of is
Viet Cong, and it seems pretty obvious from the title it’s not about them.

~~~
MarcellusDrum
Due to the quarantine and the current crisis, VC is wired to Video Conference
or Voice Chat in my brain. The title gives no clue whatsoever. How does X
works can have any word in place of X and it would still make sense.

