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.
That's such a weird thing to see coming up over and over again.
Finding an investor is like being in the casino and having a high roller give you money to bet in return for a share in the stakes because they believe you have better luck than they do themselves.
Success is when both you and the investor cash out with significantly more money than you put in or when you make the business so profitable that your accumulated dividends exceed the initial outlay.
To see VC money as 'success' is simply wrong, it may increase your chances of success, and it may cushion your losses a bit (because not all expenses come out of your pocket).
The odds of succeeding with VC is even tinier. It’s just that the media hype up the lottery winners so VC continues to have companies wanting their money.
It's a lottery, you only need one. One facebook, one google, etc. Those successes bring in RoI not just of double digit percentages (the sort you'd expect from high-risk investments) but in multiples, orders of magnitude even. 10x, 100x returns sometimes. And when you hit those jackpots all of your other investments are now meaningless. The result is that VC becomes a game of searching for jackpots. Everyone wants a little bit of everything, and everyone wants to have their fingers in the things that look most interesting, that seem to have the chance to blow up. VCs also push the companies they invest in to grow fast and hit the point of finding out whether or not they're a "jackpot" idea or not.
At the same time, investors have figured out innumerable ways to get paid out of companies that are obviously not going to make it and won't ever hit a traditional liquidity event. They've gamed the system to an enormous degree but they also pump so much money into it that it's hard to stand up to them.
I still don't understand what is so difficult about this. If you work hard, you're more likely to succeed. Not guaranteed to succeed. Luck still matters, although a lot less than people think.
Whether or not VCs are justified in earning their returns is a completely different issue. This has nothing to do with hard work and everything to do with investment and dilution.
The "controversy" is this online meme that everything is just "random" and "luck" and no one, anywhere, can ever do anything to be successful. The entire world is nothing but a Vegas casino.
It's just rationalization for laziness and frankly, it's completely uninteresting. No one who has actual business experience thinks this.
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.
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.
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.
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.
This analogy fails almost immediately. Real VCs distribute their bets across dozens of companies. You personally are placing one massive bet on one single company so your odds are far worse than a VC.
Except a huge amount of VC plays are basically just gambling on someone succeeding. They don’t care who. So you’ve got 1 success story for every 100 attempts. Sure that 1 generated outsized returns, but that doesn’t help the 100 that failed and lost time and money they could have gotten elsewhere.
Additionally, VC plays are often are parasitic endeavors that try to acquire monopoly positions by flooding the market to corner it (ie kill all competition) before raising prices (eg Uber prices raise to pretty close to taxis once the local taxis have been run out of business). If you prevented flooding the market as a tactic, the entrepreneurship model would change drastically. And that is something we used to try to prevent but for some reason we only did it once for the commodities market but let it continue unabashed everywhere else.
According to the OP, which borrows liberally from an earlier piece by someone else[a], the way to win for VC firms is by investing more capital, faster, with less due diligence, and at higher (market-clearing) valuations than competitors.
While in theory it's possible to lose money investing in startups (gasp!), there is NO mention of that possibility in this article. The concept of risk of loss appears to be... foreign to the author, I guess?
Over the past six to seven decades, the US venture capital industry has gone through a handful of boom-and-bust cycles. For example, many VC funds that launched at the peak of the last major VC boom, in 1998-2000, ended up losing 50-100% of LP capital over the next decade.
Perhaps all that "ancient" history is irrelevant now. Maybe this time it's different?
VC isn't just about placing "correct bets." This article pitches it as actually the opposite: what happens after the bet is more important than before, so fund lots of them and help them.
But even more generally outside of the YC-model VCs compete on their networks and influence as well. The more connected you are, the better you'll do - it's a feedback loop.[0]
Look at the evolution of VC companies. If the skill was just "making correct bets" wouldn't that look like making fewer, but likely larger, bets over time? You grow, on the other hand, if you have some significant influence on the odds or can't tell the odds between companies you select that well. If "success" is 1/10 odds, and "phenomenal success" is 1/100, and you don't think that you are capable of digging deeper to instead find just the ones with 1/20 phenomenal odds, you have a better shot of huge returns if you place 100 bets instead of 10. Then you get more knock-on influence of having a bigger network over time, too!
Of course, trying to control the odds is a classic old gambler move too, but if you're caught doing it in a casino "excellent gambler" may not be the label they apply to you.
[0] to a certain type of tech enthusiast, the huge political aspects here are very frustrating.
A VC makes their money on the few times they win, and it more than makes up for all the companies that lose completey. Just barely making back their investment is no better for them than returning nothing at all. (In fact, they could be putting the money into market securities with risk equal to your company's likelihood of return, so you have to give them [that same risk multiplier] * [their original investment] or they lose money, even if you give a "positive return.")
A VC would much rather give you 1mil five times and have you kill four of those companies and make a 100x return on the fifth one. Sitting around forever on the first one trying to eek out a 2x return means you never build the fifth one, and that's a much lower aggregate return.
So, honest question... What is stopping a government- or non-profit-run VC firm from investing pretty much randomly, where all of the lottery winnings go right back into the fund? Or does randomized investing not put out a net win in the end? Including companies that really go on to make billions, I would think something like this would be sustainable. But again, I have no idea. It just seems like it would be worthwhile to have an investment machine which didn't need to pay for someone's megayacht in the process of reaping returns and investing that money in even more companies.
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