Thanks! It does explain it. It's an interesting concept for sure; I guess VCs want to make sure the money they are investing is as safe as possible, and taking a hard look at the engineering behind the company is a part of the due dilligence. (If I understood the business model correctly). And startups are probably not too keen on sharing their code and IP like that but the VCs will pressure them to do it. I kinda like it :)
Great comment! This is one of the best descriptions I have read on VC investing and startup valuations.
If true, doesn't it imply VCs hand over millions without knowing details of a company and founders can benefit from delaying going public..Oh, well whaddya know
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.
I think one of the most interesting paragraphs in this essay is the one discussing where VC money comes from. This seems to be something that is not very clear on HN, and without understanding who's money it is and who is spending it, it is hard to understand the incentives behind VCs, which seems like an important thing to understand for anyone contemplating a startup.
Another thing that should be mentioned is that most VC's have a close relationship with bigger tech companies. Its a way to move money out of the public markets and back into private. There are multiple implications with this type of behavior.
This helped my understanding of VC/founder relation much better. Thanks for putting a broader perspective to the situation described in the original post.
It all boils down to this: when a VC invests money in a startup, they are putting their reputation on the line. So imposing some control over the startup just seems natural. Imagine if you had to trust $11 million on a group of strangers; installing one of their own on the startup's board gives them a birds eye view of how their money is being spent.
It's a pretty common model for VC backed startups in financial services these days, especially ones that involve risk assessment.
I think it is kind of a Potemkin village approach. Let's be honest, they don't want to actually solve the hard problems of underwriting things, they want to appear to solve them so they can impress VC's and get millions of dollars in funding for themselves. Unfortunately you can't help them with that goal.
For them, what better group to work with than the very companies that were funded by the same VC's they're trying to impress?
This approach works in both directions, since for one these companies are by definition well connected and well funded so they don't have to make tough underwriting decisions, and two VC's are for the most part living in a bubble, so by signing up a couple dozen venture backed startups they can create an "everyone is using it" impression.
Needless to say there are problems with this approach. The main one being the addressable market of VC backed startups is tiny and probably not worth that much to corner unless your revenue per customer is massive. And the other problem is that it's not clear you're actually learning anything if you're not really exposed to the wider marketplace.
They'd counter by saying they're getting good at their business and achieving scale and building a great product, and that expanding beyond their own bubble eventually will be easy once they get that product built up.
Maybe they're right. But until they do it's hard to consider any of the companies employing this model to be successful yet.
The structural and core part of the issue gets muddled due to poor education/know-how among engineers (partly due to excellent marketing by VCs). See below an excerpt from Alex Payne's article at https://al3x.net/2013/05/23/letter-to-a-young-programmer.htm...
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As a VC at a top-tier Sand Hill Road firm told me during a pitch several years ago when describing a conceptual feature in Simple that would let users easily and regularly donate a portion of their savings to charity, “let’s not waste time on that stuff; we’re here to make money”
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There are a breed of VC's who project themselves as if their sole purpose in life is to help entrepreneurs realize their dreams and that there is a higher purpose for their VC avatar. Some believe it and mean it, and some pretend (It is important to keep up the pretenses in this business lest you get shunned by all starry-eyed entrepreneurs who come to valley to change the world). VC's exist to help their investors make money. They have a fiduciary duty to do so. When you are giving away a good part of your life (sleep, money) in pursuit of a dream, and getting into a financial transaction with VCs to do so; It is vital for you to understand how they operate, how they make decisions, are incentivized to behave, and also be cognizant of their true (ulterior?) motives. VC's are a vital part of the startup eco-system. I am not against them or how they operate. They are smart enough to be politically right and make themselves desirable to entrepreneurs. All I am trying to say there is usually information/knowledge/expectation asymmetry (as pointed out in the article) when engineers are getting into financial transactions with VCs, and that they need to be cognizant and work on ways to mitigate this. [Edits for typos/grammer. Added two sentences at the end]
This is an awesome take on the VC game. I imagine it's not the only opinion, however. The metaphor he sets up with regards to customers and shareholders could also be twisted (and I'm sure is, by some VCs) to a more hierarchical idea in which the VC needs to answer to the shareholders. Some VCs may even want to stretch that notion further and say that the startup is answerable to the VC.
I think this is a less accurate analogy, but I could certainly see it giving rise to the idea of "the Patzer" as something less like a business decision and something more like a sin against the VC.
I think one of the most disturbing things about how people get rich in technology startups today is that they get chosen by rich vcs to become successful.
Let’s say there are a few different teams of people working on some promising space that requires a new solution, vcs basically decide the winner by injecting massive amounts of capital into them and make the rest fail.
Different motivations AND different evaluations of the company and market between the VCs and the founders. Also different risks and rewards for the VC and the founders.
Sometimes the VC thinks that the market the startup is in is a bubble and the VC will push for growth over long term health. Sometimes the VC is right and sometimes they are wrong.
I've seen this play out where the VC pushed for growth probably to get acquired. The VC may have been mostly right since the market was a bubble that popped. One competitor was able to pivot though and ended up with 4X. Most competitors failed. Perhaps the VC wanted the money or perhaps the VC didn't believe in the founders.
Sometimes the startup has no market and then the VC may push for actions that lead to acquisition. Sometimes the founders demand additional incentives in the acquisition.
I've seen this play out since the VCs probably at best break even and want to wash their hands and the founders threaten to stop the deal since they lost out on salary and stock founding the company.
Perhaps some answers to the future questions may lie in the past. Is the current/new toolstack always better than the old one? I'm just curious. :-)
To some extent, true, it is an exercise in validating, say, business hypotheses. I guess it's quite normal for founders. However, I’m already VC backed, so I’m not sure if your friend is really onto something. ;-)
Fair enough, and I guess we have to differentiate between VC-funded and others.
E.g. your comment might be true for VC-funded. But it may not be true for other types, e.g. bootstrapping.
But then additionally, I'm super surprised how a well-engineered product can transfer trust to potential customers. Consider, now that we've all been on the Internet for 20 years, we have well-trained bullshit sensors. So I'd say there are shades of grey in all of this.
Honestly? I don't buy it. The VCs are the ones that have been pouring cash into these companies so they can blow it on obscenely expensive parties and offices. I think they're just trying to deflect criticism away from themselves and onto the startups.
I mean, there have also been plenty of startups in the past that have blown money and built a product that nobody will pay for. And VCs just pour more cash in.
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