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The real significance of this article is related to the inside baseball of how most venture funds work. See this: http://www.theequitykicker.com/2011/01/12/how-does-the-struc... to learn more.

In brief: Most venture funds are closed-end funds, with a certain amount committed up front from LP's, where each dollar can only be invested once. The fund stops making investments after 5-7 years, then closes down entirely after 10 years. After 10 years, the managing partners stop collecting their 2% management fee, and any additional returns aren't typically included in the performance of the fund.

As such, there's a huge incentive for fund managers to invest early, and find an exit within the time horizon of their fund. A VC who pumped a ton of money into an early stage Uber in 2014 in year 6 of their fund, is going to be pretty screwed if Uber decides not to go public for another 5 years from now.

Where this could go sour is that these same fund managers are spending years 9-10 passing the hat to raise money for their next fund. If the typical pool of investors still have a lot of money tied up in previous funds, then they're going to be less likely to ante up for the next fund, since they'd have to double down on VC as a proportion of their portfolio. It's also going to be a tough road show if your story is that you invested millions of dollars in your last fund and it's all still tied up ...






I'm an LP in three venture funds. Typically there's an initial capital call when we commit to the fund, then 25% per year (you can end up with two capital calls in the first year depending on timing). The funds I invest in focus on very early rounds (seed or Series A) for initial investments, keeping $ in reserve for follow–on investments.

After about 18-24 months they raise the next fund.

With the GP I work with there's almost no overhead, just two GPs and the annual accounting. The annual accounting and tax filings can cause additional capital calls (small amounts, US$1500-2000).

As an LP (and a tiny one at that), one of the problems I'm seeing is that companies are raising ever larger up rounds at ever increasing valuations, giving away massive preferences to the later investors. This boxes the companies into seeking either grandiose exits justifying the valuations, or they wipe out the early investors (and employees) because of the preferences overhang with the finial investors (typically institutional money).

It's been an eye opening experience, I've learned a lot. Unsure how much more money I'll commit to investing this way though.


Could you speak more about why re-investments cannot be made? It seems the inability to re-invest would skew decisions towards 10x and 100x returns rather than a series of 1.5x returns done many times. My background is mostly Wall St, and for us, a 1% return on a small horizon is great -- since you can just keep repeating it. Why would GPs be blocked from doing something similar where they aim for quick base hits rather than a grand slam?

Because of the rate of failure for early stage startups are high, the need for individual winning investments to make up for the other losses AND generate the required returns for both the LPs and the carry for the fund managers would require that base hits for winners are not sufficient. The wins need to be much more significant to allow the portfolio as a whole to have acceptable returns. In general I agree with you -- I prefer shorter-horizon lower-scale repeatable wins over longer-horizon, high-risk, potentially greater returns. I honestly think venture investing is successful for only a small number of entities who happen to either have some sort of inside track into superior deal flow, and ability to CREATE winners by influencing markets (exit markets especially), or some sort of strategic advantage in their industry. Otherwise it's 100% luck. As an individual investor, I think angel investing is very much an easy way to part with a lot of money. I stopped angel investing when I realized it was high-risk gambling/speculation combined with some sort of philanthropy combined with ego-centric elbow rubbing with others. I've got a stock-based swing strategy I'm working instead. Lower downside risk, with equal potential gains at scale.

I honestly don't know except from my experience that the goal is to keep the fund as low cost as possible: invest in a bunch of companies early, invest in follow-on rounds over next couple of years, and otherwise keep overhead down.

The funds I'm in don't take board seats, though they do offer access to its network of investors and contacts to the companies it invests in. Different funds are run different ways. The GPs of the funds I'm in do not do this as their primary job, other funds have principals (GPs or other forms of partners) who draw their income from the funds in one way or another.

Other considerations: the funds have a limited lifespan (I believe each of the three I'm in are 10 year limited partnerships with an option to extend by simple majority vote of LPs). Because they're limited partnerships, the returns get reported as income to the IRS, and I'd owe taxes on them, even if they were not distributed, which is another reason not to re-invest returns (if the returns were re–invested, you could potentially pay taxes on income which then gets "lost" when re–invested in a startup which fails).

I commented elsewhere in this thread that so far across three funds we're seeing the 33% fail, 33% break even (modest returns) and 33% either have returned the fund or have potential to do so, which is a pattern I've seen repeated by many venture funds over the years I've been following or investing in them.


I can't speak to the reasoning, but that's exactly the impact. I was at a start-up that needed bridge financing to pay off some debt; we had a customer placing orders and we were literally months from being insanely profitable. It was late 2008 - early 09, in the depths of the financial crisis. No bank would touch us, and VC's wanted a minimum 2x return on their investment. We ultimately ended up having to sell the company.

How do you get into this line of business, do you need to have a lot of connections to Wall Street already?

In my case: I knew a guy who wanted to start a venture fund, and he focused on an area that appealed to me (mix of IOT, healthtech, weird stuff). I qualify as an accredited investor (in the US). And I have a small amount of money I'm willing to set fire to in the hope that a chunk of it has excellent returns. So far across three funds (with same GP), Fred Wilson's 33/33/33 split is holding true.

An individual LP in a fund is typically just a wealthy person. Historically the term was an accredited investor which was a legal definition that set minimum wealth/income standards. This changed recently with the JOBS act but I haven't kept up with the latest requirements. Often times they are former entrepreneurs or high income individuals (lawyers, doctors, corporate VPs, senior engineers etc).

In practice, this is not the major pain point I think you are calling it. The letters I read often have variants of "We've returned [0.8-2.5x] capital and still have [Uber] in the portfolio!"

What may be painful is not being able to at least return capital by the end of the fund without a WONDERFUL story about coming liquidity.

Current industry average 10 year IRR is 10% according to Cambridge Associates. You've really fucked things up badly if you can't return capital in year 9/10 on a 10% IRR.


To save others the trip to Wolfram Alpha:

Assuming money is put into the fund in year 0, a return of 2.35x capital in year 9 or 2.6x capital in year 10 is required to get a 10% IRR.


Distributing shares of a private company at fund liquidation is not unheard of either. In some cases (Box, Groupon, LendingClub) distributing early at private valuations allows to record a better IRR than subsequent public valuations.

Is that real return? (i.e. adjusted for inflation)

Or even better, is that comparative performance, i.e. 10% better than a vanguard index fund?


> It's also going to be a tough road show if your story is that you invested millions of dollars in your last fund and it's all still tied up

Depends on what you promised those investors and how the fund is doing. Nobody complains about being in SpaceX or Uber.





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