> The problem is that when they fail, their clients lose money, and they don't.
This isn't really a problem - they only take accredited investors because of this risk.
VCs also lose money when startups fail, but they don't ask the founders and employees to pony up past salaries. Understanding of the risk of failure with no recourse is a prerequisite to investing.
> There is no person (a) who doesn't meet the accredited investor requirement and (b) for whom an illiquid, volatile security like start-up equity is a prudent risk-reward decision.
You say this as if its obvious, but I'm not even convinced that it's true.
Sure, there are all sorts of strategies that VC firms employ to mitigate their downside, but those are only marginally effective. The real reason the successful ones are successful is because they were part of the right deals, not because they lost less money on the wrong ones.
Modern portfolio theory is adequate protection from that kind of risk.
They're already putting money at risk by investing in startups that are obvious flops. Or even startups that do stuff that won't fly even with western-style legal framework (Theranos).
> Many of those failures are capable of generating reasonable incomes for employees and founders for years, but those incomes are not proxies for investment returns.
That's part of my point. The current VC model causes failures of businesses that are viable going concerns, but not growing fast enough. They know they can make more overall by pushing a subset of those business to explode at the cost of killing most of the others. This also allows them to increase the velocity of their investments, further pressuring their startups to grow or fail fast. Their "cohort of pedigreed startups with plausible business plans and some degree of traction" should yield enough moderate successes to make investment profitable, as long as they are willing to play the long game.
Also, those incomes become proxies for investment returns once the company is stable enough to start paying distributions to its owners. Again, though, that ties up capital for the long term, which is anathema to the current VC crowd.
> SO if a startup is too risky for VC capital, 9 times out of 10 they are too risky for debt as well. Any startups who think they have loans as a backup option if they can't raise their next round are in a for a tough wake up call.
Reminds me of the one startup we once partnered with that were entirely bank funded through a major R&D effort. I'm still in awe at the financial discipline it took them, given that the bank released money in tranches equivalent to what he needed for 1-2 months at a time, entirely contingent on meeting extremely narrow performance targets to convince the bank they were on track and still met the risk profile. Mess up the slightest little bit even one month, and they'd be totally at the mercy of their bank manager. The bank saw it as borderline in terms of their risk.
Meanwhile, if they'd gone to a VC with the business in the state it was in, the VCs would be metaphorically throwing stacks of money at the company.
> One of the articles of faith in this industry is that good startups get investment and succeed, while bad ones fail.
Is it? I thought it was that startups with exciting books and good networks get a chance to ratchet into the next round of funding.
Great startups drown all the time for not being a VC rocketship, when they they could have grow into a perfectly successful cruiseliner under traditional fundraising or bootstrapping.
If investors are “nah pass”, it’s more about making a quick decision about near-term finance opportunities than the mid-term or long-term strength of the underlying business. VC investors inherently care more about 10x exits than sound business practices.
> A VC which is a serial idiot will eventually run out of money.
This is not really true as VCs are not the sources of the money they invest. VCs raise money from their backers and there really is a (virtually) infinite amount of money available to raise, even for a repeatedly unsuccessful VC firm.
As with the startups themselves, the key skill is raising, not earning the actual ROI.
>This is why everyone who is smart about raising money for ventures underpromises and overdelivers. The opposite, overpromising and underdelivering, is a road to hell.
The vast majority of startups fail! From a financial point of view, most startups look a lot like Ponzi schemes; the difference is that startup investors know it's risky.
> You should try to limit yourself to opportunities that could be $10 billion companies if they work (which means they have, at least, a fast-growing market and some sort of pricing power). The power law is that powerful. This is easy to say and hard to do, and I’ve been guilty of violating the principle many times. But the data are clear—the failures don’t matter much, the small successes don’t matter much, and the giant returns are where everything happens.
This is the main reason why most people should avoid VC money. As a founder/employee all of your eggs are in one basket and the chance of having a billion dollar exit is practically 0. VCs get to raise billion dollar rounds, live off of the 2-3% management fees and go around spraying and praying with the hope of hitting a unicorn. If that doesn't work they take their top donkeys and try to pump and dump them, marking up their investments in the process in order to raise another round.
>The rule of thumb among venture capitalists is that some 20 percent to 30 percent of companies fail, returning nothing to any investor, including the venture capitalists.
Earlier in the article, it mentions the statistic that I'm familiar with, which is that roughly 75% of venture-backed companies fail.
> They’re investing in startups that have the potential to get something like 1,500% or 5,000% returns on their money and many times, they eventually succeed
And many, many, many more times they fail. The higher the risk-free interest rate, the higher the returns need to be to justify high-risk investment unless, like SBF, you simply eschew risk premiums. But most sane people, even VCs, aren’t that risk insensitive.
> The usual way for VC backed companies to fail is they either get sold for pennies on the dollar to PE or a competitor, or they wind down, fire their employees, shut down their cloud instances and either become little restaurants on the web, zombies or simply cease to be.
So if you get a loan and fail, and the business isn't worth taking over by the creditors to operate or sell, you wind down, fire employees, shut down the cloud instances, sell off the furniture. If The VC's investment terms allow for a clawback of capital, the exact same thing happens but we don't call it a bankruptcy, they just don't lose their full investment and the bankruptcy stats look great.
>Investors are looking for a particular curve. The slow burn, 7-figure exit that founders want is almost useless to VCs. The model requires that the winners pay for the losers. The VC has a finite number of at-bats every year, and each one needs to potentially be an out-of-the-park home run. A company that deliberately bunts is costing the VC an opportunity to recoup their losses on failures, which is the majority of their portfolio.
This is the problem isn't it. Investors are basically saying unless you can hit 30% month on month growth then we aren't interested in you, but if you do what is required to hit this target then we won't give you the funding to do this with a reasonable runway.
>Safe, conservative plans are awesome. That's why companies should bootstrap.
I agree 100%. Almost all founders should avoid taking VC money and just bootstrap. This of course is not the sort of meme that is popular with VCs.
> "It might be okay for founders who take a couple million off the table at the B round or VCs who keep the IRR on their books, but for employees it’s a fail."
Does that actually happen? I've always wondered if founders walked away from failed startups having made a couple million off the funding rounds... How common is that?
> I assume that VCs aren't going to throw 10 million dollars at somebody without doing atleast some due diligence.
This is a dangerous assumption.
VCs often trust founders more than they should, especially when it comes to areas the VCs are not knowledgeable. Add in an idea that would obviously be adopted everywhere, and the allure of a billion dollar idea overrides sanity checks.
>Not particularly great advice though, because then the challenge becomes identify those startups.
Only 1 out of 100 companies, if that, VCs invest in don't go out of business. Even with their ton of experience, their smart people, and all kinds of opportunities that you don't have, it's little more than guesswork on their side.
Trying to look for what is going to be a successful startup is a fool's errand. Pure luck.
This isn't really a problem - they only take accredited investors because of this risk.
VCs also lose money when startups fail, but they don't ask the founders and employees to pony up past salaries. Understanding of the risk of failure with no recourse is a prerequisite to investing.
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