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Jason Fried: “Venture capital money kills more businesses than it helps” (recode.net)
98 points by yarapavan 27 days ago | hide | past | web | favorite | 32 comments

VCs want binary outcomes - either something grows 100 times or it dies. This is not because they are evil, or crazy (and don't want money from a slow growth but still money earning business) - but because this is a way to avoid principal agent problem (https://medium.com/@zby/the-problem-with-crowdfunding-81b53f...). If you don't want that - then don't take VC money. Fried is right with that, but the VC model works well in fields where there is a strong first comer advantage (like everything with network effects). Because there if you don't outgrow your competition - then you are dead.

I don’t get it. How does it help to avoid principal agent problem. The link also states it as a fact with no explanation.

The link says:

> This relies on the theory that startups goal is to grow a 100 times or die — so small continuous extractions by the executives are ruled out.

I interpret it as following: if the regular company earns $1 million/year, then an executive stealing $500k/year by making deals with friends will make investor's return much smaller. But in a startup, it does not matter -- if the it fails, it would simply fail slightly earlier. And if it succeeds, then it would earn $100 million/year, and $500k/year that executive steals will be a small, insignificant change.

(I am not personally convinced this is true, but this is how I interpreted that article)

There is one more additional thing: graft also takes effort, the easy things are also easy to control. The founder can either work on the startup or on the extractions. The point is to make the extractions relatively less attractive than the success of the startup.

I guess, but why steal $500K a year, when you can steal millions? Certain insider deals from a certain very large unicorn are what I'm thinking about.

VC investing is on a spectrum - at companies already at the unicorn stage it is more private equity than what happens at earlier stages. Also now partial liquidity events for the founders are a standard. They improve the incentives alignment at these later stages.

70% of VC backed founders end up with zero in capital gains, after toiling for 5-10 years... primary reason is they are "forced" to grow at unnatural high rates, to attempt to deliver exponential 50x returns to their (diversified) VCs, which usually doesn't work out.

I wonder how that number would be different, for those very same companies, had they not taken investors?

70% of tech startups (or even more) fail on themselves and not just because they took VC money. It's just a risky asset class and people should understand that. And the most of them would be impossible to properly launch without significant initial investments as most of the time the idea is to reach near zero marginal costs and scale by investing a lot in your tech/community.

Main point is the startup risk is unnaturally amplified by capital, which increases monthly costs, with the hope of generating unnatural growth rates that never arrive...

It'd be really interesting to see the failure rate of bootstrapped tech startups vs. those that took VC money, I'm betting it'd be a lot lower.

They'd probably toil for 5-10 years for wages significantly less than what they could've earned working for a FAANG. At least, that's the usual outcome I see for bootstrapped founders.

VCs react to the extreme winner-take-all dynamics of the economy, they don't cause it. Those dynamics will still chew you up and spit you out even if you don't take VC, they'll just do so with a lot less drama and nobody to blame.

There are ~30 million businesses in the US. What's this natural winner-take-all dynamic you talk about?

This thread isn't about businesses in general, it's about tech businesses. Most of those businesses are in commodity markets like restaurants, hair salons, auto body shops, professional services, and other local businesses. There are geographic barriers to entry for one company taking over the whole market in those industries (not that that necessarily stops them - witness McDonalds and Wal-Mart). There are no such barriers to entry on the Internet. The Internet is new, which means that a number of niches sprung up in the last few years. Most people I know who've capitalized on them make a good living for about 5 years and then find that customers dry up as the industry matures, the next technology platform arrives, and the industry leaders eat up all the rest.

That's not how I see it. We don't see a winner-takes-all in things like project/productivity/development/collaboration tools, etc. The fact that the barriers of entry are low make it so! There's no reason to believe that small independent tech businesses can't earn their owners a sustainable FAANG-like salary in tech businesses with low capital needs. It's when there's high capital requirements that we actually get a winner-takes-all, such as with building data centers, or doing highly regulated stuff, etc.

Just wait. ;-) Low barrier to entry tends to drive down profits until they're just above the opportunity cost of working anywhere else. FAANG salaries are inflated because those companies have monopolies in their industry, so they make massive profits and can push some small portion of that down to employees to ensure they get their pick of applicants. Economically, the returns to small SaaS businesses without barriers to entry should eventually trend toward the median for programmers in general once sufficient time has passed that they no longer hold a monopoly in their industry.

I think there's a happy path between bootstrapping your own company and taking millions in VC funding, where you can place your customers ahead of delivering investor returns but not have to design your products and roadmaps due to financial limitations. On that note, TinySeed is open for applications until 2/15 :) https://tinyseed.com/

(I'm not affiliated with them, but I read Rob Walling's "Start Small, Stay Small" and it was the best book out of 70ish books I've read in two years)

I've been following TinySeed for a few weeks now, it's such an interesting idea!

Another great book that I'd recommend is Lost and Founder (TinySeed's terms are based on the Rand Fishkin's most recent startup terms).

There is....there are investors who don't require 100x returns. It's just harder to find them, they're usually more risk averse, and you'll need a way to return their money that doesn't necessarily include an IPO.

Not clear to me why someone would want to invest in high risk startups for a low-mid return.. there are much safer options that would give similar returns.

From my understanding, VC funds as an asset class don't perform that well. A few of them hit the jackpot, but if someone spreads their bets across a number of funds, I would be surprised if they beat the market. So keep that in mind when comparing returns.

Another thing to consider, is that focusing on the 'middle road' does not necessarily preclude a company from swinging for the fences, it merely sets the incentives such that getting to profitability sooner is advantageous. They do this by encouraging dividends as a form of compensation, but the company still has the option of going the VC route.

So if anything, I think this structure is the best of both worlds. If a company can take ~$100k in seed for ~10% in equity and turn that into a small business worth $10M, that is a 10x return. But if it looks like they are on to something bigger, they can raise another round and keep grinding.

Some Angels too. I have ran into small startups that are forced to make poor/crippling choices because their angel(s) would rather not spend anymore money before flipping the company.

Why are these articles always aimed at the 'victim' companies, rather than the actual venture capitalists?

If the thesis is correct, they are the main losers, with incentives to find the 'right' size for companies.

Edit: I am aware of the current business model of venture capitalists.

It just seems to me that the value maximising outcome would be to enlarge every company to the largest it could be but no bigger.

Why isn't this happening?

Is it that venture capitalists are psychopaths and bad investors to boot? Is it that identifying the 'right' size of company is hard? The question that then arises is why are founders so good at identifying the right size, when investors find it so hard? Is there survival bias here? Sour grapes? If founders are genuinely better, why hasn't that been picked up on and harnessed?

They're not losers if the profits from a few big winners outweigh the losses from the losers.

That works out for VCs because they're diversified. A founder lacks the diversification, so while their average expected return is the same, their specific outcome is likely to be poor. They'd be much better off with a strategy that has lower expectation but also less variance.

VCs also have a resource that is much more scale-able, especially in a horizontal direction, money.

Most founders don't have the ability to diversify anywhere near the same degree because the resources they have personal control over (time, energy) are generally much more limited.

I think the thesis is that if you can spread your risk out across 100 companies then the math can work out and it can be a good bet, because you only need one of those to be a huge success and make up for all the failures. But if you are only invested in one startup, it's a horrible bet. So it can definitely make rational sense for the VC but not for the founders.

The corollary is that taking vast VC money is the best way to grow to be a $1B business (obviously there are some exceptions). Again, all these things can be true. If you're a founder and determined to have a billion dollar company, you should take VC money. But your chances of success are miniscule. If, on the other hand, you're a founder and just want to build a $20m business, don't take VC money and the odds improve dramatically.

The idea is that the venture capitalist's motivations aren't necessarily aligned with the company's. They're interested in creating a unicorn, because that one company will create the returns necessary to turn a profit on a huge number of attempts. So they attempt to quickly build huge companies with everything they touch, in an effort to get that one that will pay off. Many companies end up being overbuilt to a point where their sales can't sustain their size, in the interest of attempting to have the capacity for future sales.

Yes but the venture capitalist that manages to identify non unicorn, but still big companies has an advantage.

A fund that gets 1% unicorns might be successful, one that gets 1% unicorns and 5% big companies still has an advantage.

Which fund would you invest in?

As a VC? The unicorn fund. Which agrees with what the market has been supporting this last decade.

Given the same investments in each, the unicorn provides a bigger return. Because of economies of scale, it's more likely to gain traction and continue its success, especially in a place like tech where marginal cost is almost non-existent. Not to mention the overhead on managing a single investment vs. many. Not to mention the administrative costs of 5 companies vs one. Not to mention the benefit of choosing a company based on your interests and abilities, since most VCs have a more hands-on role than traditional investors.

It just aligns with the culture; the whole idea in most tech startups is to leverage economies of scale as much as possible. Often their profit per customer is tiny. They're relying on millions of people using the product.

>As a VC?

No as an individual investing in VCs.

VC A invests in 100 companies, 1 turns into a unicorn, 99 go bust.

VC B invests in 100 companies, 1 turns into a unicorn, 5 turn into (slightly less) large successful companies, 94 go bust.

I agree with the OP’s point. In a race of unicorns the length of the horns matter.

A Facebook trumps a portfolio of LinkedIn, Tumblr, Snapchat, Box, Nest anyday.

I've restated it twice now, I'm confused as to why I'm being misread.

Unicorn _and_ 5 big companies.

A portfolio of Facebook _and_ LinkedIn, Tumblr, Snapchat, Box, Nest would trump both.

See, I treat LinkedIn as a unicorn.

Venture capitalists see a whisp of smoke and dump a truckload of firewood on the first embers.

They want a big bonfire asap, and don’t really care if they end up extinguishing the flames instead.

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