Why startups don’t die at large hedge funds | Hacker News Reader

Why startups don’t die at large hedge funds

jonsteinberg.com

49 pointscwan37 comments

The perceived risk vs reward on a tech startup venture vs. playing the markets is completely different.

In hedge funds, earners get their big juicy paychecks when they prove they are earners. The methods by which you make money, while varied, are a far more known set. In general, you're not going to talk to a finance guy about what he's doing and then walk away thinking they're an idiot. Look at the scorecard, they must be doing something right.

In tech, the opposite is true. Ideas that seem far-fetched or absurd blossom. Sure fire hits crumble. Things that seem insane one year become obvious the next. Startups are incredibly speculative because we're exploring unknown spaces. But that's why you take the risk and go out there... because nobody else believes in it as much as you do.

If you add the bureaucracy of a large company to the mix, there are too many people in the way to say no. To crush the idea and the team before it even exists. And that's why as founders, we quit.

Agreed. This is one of the areas of business where the MBA graduates of this century can and should really focus on: restructuring the modern corporation to allow for proper incentives and encourage innovation. Companies these days are more internally communist, with top-down centralized command. See http://www.salaminder.com/2010/02/large-corporations-inheren...

"This is one of the areas of business where the MBA graduates of this century can and should really focus on: restructuring the modern corporation to allow for proper incentives and encourage innovation."

MBA grads might be the worst people to attempt this. A typical MBA grad is no shape to make innovative changes in a corporation.

Sorry to be harsh about this - but this is borne out of the reality of having worked with MBAs at startups and huge corporations: If you want innovation, first step - fire the MBAs.

Or maybe you should learn to hire innovative MBAs ? - a lot of stupid MBA bashing completely ignores the fact that there are a lot of MBAs driving very successful start-ups and large tech companies. Especially if you look at business rather than consumer focused start-ups.

There are crappy MBAs just as there are crappy programmers. Thinking that all programmers are crappy because you've only worked with crappy programmers is a logical fallacy.

I continue to be amazed that big companies don't do this. The first big tech company to figure out how to successfully do mini-startups within the company (with slightly less risk and slightly less reward for the engineers involved) will sweep all before it until their competitors figure out the trick.

I work for a large company that does this. Granted it's all consulting, but promotion into the upper reaches depends on creating a successful nitch which is effectively an autonomous business. It’s not uncommon for someone to internally develop a piece of software, “sell” it to a government and then get a support contract. Pay is also directly linked to how successful their mini businesses are. However, they decided to mostly stick with consulting and don’t sell products directly to customers.

It's been tried in a lot of different settings, generally with very mixed results in my experience.

I started my career at Acxiom (think data warehousing/personal information data mining/etc...). Each division in Acxiom was split up into business units that all operated fairly autonomously. If you wanted to use company resources outside of your unit, you had to pay for them in real dollars from your business unit.

It led to all sorts of really bizarre product development. The particular product I was working on was one of three (that I knew of) within the company all doing almost exactly the same thing with very minor differences between them. One customer would ask for the tool and far to often business units would just start building it themselves.

Really the issue seemed to be that the failure rate for these business units was pretty close to startup failure rates. Which is simply intolerable for most companies. Your business shouldn't essentially be a big VC firm fronting a lot of small internal 'startups'.

I've run across several other examples at various levels of scale. Microsoft, in some ways, is organized along the same lines for one instance.

Isn't Google a good example of this with 20% time?

No because the reward is small compared to starting a startup. You might be lucky at Google and get a huge bonus, but it is not the same as having a cut of the money generated by your product.

Agreed...the system doesn't fully work. This is why people have to leave, create value, and then sell their companies back i.e. Vark

If Google gave employees even just 20% of profits generated from the products they build or prototype, that system would fully work for everyone.

You don't think 7 figures is enough of a bonus?

Considering the employees are taking zero risk, I'd say it's perfectly fair compensation.

http://news.softpedia.com/news/Chrome-Team-Gets-Millions-in-...

Many people (including me) have wondered why large tech companies don't do this, and many people (including me) have quit and founded startups instead. I think it must be intrinsically hard to do. Look at it this way: there already is a mechanism for spawning startups that distinguishes winners and lets founders reap rewards. It's called the open market. So essentially, for an organization to succeed at this would mean beating the market. That's hard.

I'm unconvinced by the analogy between hedge fund managers and startups. The variation in what the former are doing is miniscule compared to the variation in the latter. That doesn't make it easy to be a winning trader, but it does make it far easier to identify winning traders and build an organization around them.

I don't think the article is exactly right. Young managers stick around at hedge funds not just because they get incentivized with a percentage of their returns, but also because it is hard for them to raise sufficient capital to start their own fund. Most of them would probably prefer to manage that 25-100M in their own fund and take the entire 20% of generated returns instead of sharing it with the fund. Generally when they have the experience and contacts to do so they _do_ go out and start their own fund.

Quite the opposite, it doesn't take much capital to start a web company any more. Consequently, lots of teams of engineers can leave a big company and build up value on their own with out the support structure (i.e. capital) of a bigger company. Then they have the freedom to get paid the market value of their work in an exit, instead of their returns being determined by a single party (the company they worked for) with no competition.

This is an interesting idea, but I don't think that there's any real substitute for going out and starting your own company. In any big company (no matter how good or liberal technology-wise), there's always an element of inertia. That is to say that there's always a sizable group of people who will resist change for resisting change's sake.

I simply don't think there's any way to remove that element without leaving the company altogether.

that's the point of what the op is suggesting - that you grant internal teams full autonomy

This doesn't always work, though: Jeff Bezos worked for a large hedge fund (D.E. Shaw) before starting Amazon, and pitched the idea to management -- and only left to found Amazon on his own when Shaw wasn't interested.

Starting an online commerce firm from inside a hedge fund is not exactly what this guy is talking about. He's talking about allowing promising managers to invest money (which is a hedge fund's business) without excessive direct interference from more senior managers and with a direct stake in the outcome. D.E. Shaw is not an internet company (Juno aside). What the author is suggesting would be something like Google giving operational autonomy and a percentage of the profits to the guys who came up with gmail.

Yes that's what I meant. There is too much top down at all the major tech companies.

No one tells a pad manager at DE Shaw what to do. He either thrives or blows himself up and is fired.

I would wager that if you were to aggressively short other traders' portfolios in your own fund, you'd quickly find that there are limits to the independence of your pad.

Selling into the same consumer segment is much more cannibalistic than finding varying arb opportunities in different market segments.

No, the shortedn traders would either wise up quick and change strategy or get fired.

The value of a money manager at a hedge fund is easier to objectively and fairly measure than the value of a startup.

Even if an Internet behemoth like Google paid engineers large sums for their successful 'internal startups', I don't see how they'd come up with the same value as a competitive acquisition process with the startup retaining the option to walk away and carry on independently. Entrepreneurs would still leave in order to avoid being subject to the whims of the one and only one potential 'acquirer'.

The valuing is tricky, but the M&A groups do it every day.

prediction markets

This is one reason large tech companies do spin outs, though I am not sure of any companies that have become overwhelmingly effective at it.

Rather than the big companies taking the risk of funding many "pads" most of which will fail they let other people put their money at risk and only end up buying the proven winners. How much money would they have had to throw at failed "pads" before getting Aardvark? If the answer is more than $50 million then they got a good deal.

Thats a fair analysis. I bet its less than $50M. Also there's a lot of wasted value by not allowing for autonomy. Look at MSFT http://www.nytimes.com/2010/02/04/opinion/04brass.html?scp=2...

You wrote a good post. It reminded me of 'The Origins of Wealth' by Beinhocker. He spends a lot of time exploring why most companies spend most of their time playing it safe and why so little is spent on exploring new markets/business models.

He also makes the point that most companies don't survive very long. I don't think tech is especially unique in this regard.

People probably don't leave the hedge funds because they are in a great situation. Hedge funds managers get to play the heads I win tails I get a management fee game. People, once they have wealth, can be surprisingly risk averse and don't want to risk substantial portions of their own wealth as capital in a new venture.

In tech companies market position matters. You can't just have everyone working on their pet project, because they all have to fit together to form a cohesive unit with adequate positioning and power. Except for the occasional market manipulation, that's just not true with hedge funds.

Considering the overall poor performance of the hedge-fund managers compensated in this fashion, isn't this a model not to follow?

I'd actually like to see the citation for the poor performance of hedge fund managers, or are you just basing this comment on the recent media portrayal?

Here's one analysis, which while not all bad, is not particularly positive either: http://www.cfapubs.org/loi/doi/abs/10.2469/faj.v61.n6.2775

Thanks for pointing this one out. I'm looking forward to a year or two from now when someone can do a study of hedge fund performance net of fees vs. a benchmark such as S&P500 over the last 10-20 years including 2008 and 2009. I would expect hedge funds to outperform, and the last 2 years have been a once-in-a-generation event to check that hypothesis against.

hedge funds have gotten away with poor performance due to naivety and poor due diligence from investors. hedge funds managers are just following their incentives, it's up to investors to shape the right incentive

"Otherwise we are resigned to this cycle of great tech companies having relatively short lives compared to industrial counterparts."

What's the problem here? Did I miss the lesson on why we need to create long lived legal entities? It's not even on my priority list.

Of course tech companies don't do this, it's all about risk. Tech startups are difficult, expensive, and high risk. It takes the right kind of people to start something successful, most people can't do it. Places like Bell Labs don't exist anymore predominantly because it's cheaper to let other people cover the risk, and only buy companies that have a product and significant traction.

Hedge fund managers don't have a 90% chance of producing something nobody wants and losing all the money that was invested in them.

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