Someone should do a study to see if the lottery effect--where winning the lottery leaves you worse off because you don't know how to handle that much money--is at work with VC funding.
The lottery is not a very good analogy. Let’s look at worst cases. In the lottery you put in cash and usually get nothing back. You literally learn nothing because every draw is random. At a VC-backed startup someone else gives you money. With that money you’re expected to pay yourself a salary. You get to learn at an incredibly fast rate on someone else’s dime. And you get that salary and learning even if your investors are awful and push you to do terrible things and you agree to do those terrible things and they tank the company. In the worst case, it’s a free education with room and board included. And, if it works, there’s a helluva upside.
So, lottery expected worst case: you lose all your money. VC-backed startup expected worst case: you learn a ton and end up no worse financially than you started.
As an aside, whether venture-backed or bootstrapped, having gotten to know a lot of successful founders the characteristic that seems to set them apart is their rate of learning. The best are relentlessly curious, always assume there’s something they don’t know, and seek to learn from as many people as possible.
People lose money in lottery tickets, casinos, equity investments, etc all the time. If a VC is successful over a period of time with a history of investing in winners, then there is something more than simply randomness.
Most VC funding is about winning the lottery. But where an actual lottery is a zero-sum game (less than, actually), in the VC lottery many investors can be winners, all it takes is being sufficiently diversified into enough different startups with strong potential.
Not everyone is going to win the facebook lottery (Accel Partners, for example, achieved a ~40,000% RoI), but there are lots of lotteries in play. And the VCs that win those lotteries then end up with the most money. So the most money in play in VC-land tends to be from people who have played the lottery game and like it, so they want to continue to play the lottery game.
It's impossible to know as getting VC investment increases the odds of success or at least surviving to the point where you can even attempt to have a go. Clearly some are better than others at choosing winners. Part of me thinks that this could be driven by network more than competence though.
I know this is the case but I wonder if this is a self-fulfilling prophesy.
I can easily imagine an alternate reality where VCs invest more thoughtfully based on more careful analysis of companies and they would have a much higher success rate and end up with even higher returns without creating unsustainable wealth inequality.
But lottery returns might be better than startup returns. In both cases, investor sentiment is hyper-focused on the very, very low probability event of a high return, but unlike startups, the lottery's returns are deliberately smoothed to keep people playing.
That doesn't make lotto better than startups; the lotto is obviously objectively much worse. But the financial outcome of an unsophisticated investment in startups is likely to be worse than a lottery ticket; if you buy a bunch of lottery tickets, you'll get something back. If you don't know the industry, investing in startups is like throwing your money away.
I think something people don't consider in these discussions is that the current startup ecosystem --- the one in which the majority of companies return zero to their investors! --- is the product of relatively sophisticated investment. It's not impossible for a huckster to get funded, but it's troublesome enough that truly fraudulent companies are the exception.
All that changes once you set up a structure that allows people to "fund" companies "retail".
(To be pedantic) I don't. I allow that VC information and experience supply no information about the outcome, and that the failure rates of VC-backed projects and Kickstarter projects could be identical. I didn't allow for information and experience negatively effecting VC success rates, though.
edit: I accept that that's entirely possible, I just think it's a better subject for a academic study than for a rule of thumb.
Doesn't this depend upon how your stratify the data?
That technicality aside, two points worth making: (1) VC funds are like startups. All of the money (that is made) investing in the winners, not the losers; and (2) The other side of the coin: VC is also like investing in hollywood Films and pro-sports franchises. People have an irrational desire 'to be in the game', and much value can be extracted through (what is best thought of as) dark externalities.
Vinod Khosla once said he was shocked at how good of a deal VC funding was for the entrepreneur. "Heads I win, tails you lose." It's the same thing for bankers, traders, and managers of 2/20 funds. If things collapse, they're already rich. Sure, it might be difficult to raise another fund, but if you've already stashed $10mm+, who cares? Gambling with other people's money, therein lies the incentive problem.
I think that the data in the article shows it's not just "all lottery tickets" - there's a meaningful difference between the odds depending on stage and "top tier" VC's do make a difference - just because your anecdotal experience doesn't align with the data doesn't mean the trend isn't there. Looks like the authors run a site where they highlight the best startups to join, and include other factors like headcount growth and traction so you're not just relying on VC pedigree.
It would be interesting to see a truly data-driven study of VC decisionmaking outcomes.
Do dumb VC's (of less than average intelligence or academic performance) do better?
How does a VC's educational background affect their success rate?
Unfortunately we will never be able to ask these questions of a high-quality dataset, since only funds with better than average performance will want to participate and much of the data is not public record.
While you where downvoted that’s likely somewhat true. VC’s have strong incentives to invest all their money even if it means the fund only breaks even vs turns a small profit.
In turn that drives up many costs like salaries and rent for the startup ecosystem. So, less money likely results in fewer but stronger startups.
The issue is the best returns are for more risky bets that may not be funded in such an environment.
Companies without VC funding also fail. They may fail at a higher rate than companies with VC funding. I wouldn't be surprised if that was the case, because you have to be pretty good at whatever you do to raise a series A round. So even if VCs didn't help the companies they funded at all, the companies they fund might do better than the ones they don't.
Instead of simply assuming that one of two equally plausible alternatives is true, it would be useful if David tried looking at the world and trying to figure out which actually is true. I'm not asking for a scientific study. It would be a start just to find an industry where some participants are VC funded and some aren't, and then look at how they each fared.
I've always assumed VCs take gambles like this because they know it just takes a single success to cover their lost bets.
So being first to bet on a possible winner is probably statistically better than taking the time to sift through the actual details of these startup ideas.
reply