Comment by mbesto | Hacker News Reader

Comment by mbesto | Hacker News Reader

I do technical diligence for a living so I feel like I should chime in.

1. Many of my clients are unsophisticated when it comes to technology, regardless of whether they buy a "tech company" or not. Yes this includes both PE and VC clients. When a PE firm makes an investment in a tech company (and take 51+% of the company) they need to be confident the technology will hold up. About 90% of my work is PE, with the other being 10% in VC (mostly Series A +). Believe it or not, many commercially successful companies do not always use "today's world of SaaS tools, APIs, and cloud infrastructure". And even if they do, just because you use AWS doesn't mean you've setup a VPC correctly, you have multi-az setup, or sensitive data isn't encrypted at rest. These can have potentially costly (i.e. lose customers / brand recognition) consequences. (case in point -> https://news.ycombinator.com/item?id=11999712 )

2. If you're a VC, and especially an early stage one, then no, due diligence isn't necessary. At all in fact (including finance, etc). You're thesis isn't aligned with careful analysis, it's spray and pray, so diligence isn't a worthwhile endeavor. I wonder if something prompted the author to write this or if it's just a random rambling. I thought it was pretty well understood that doing diligence at the angel/seed stage was almost unanimously worthless.

3. Tech due diligence at the later stage of VC, if done right, has more to do about scalability of operations and processes then it does about the specific tech. When you put $50M into a company, spending $50k is a pretty good safeguard.

4. Tech diligence, by the right partner, could have certainly identified risks at Theranos or uBeam (assuming there are some there), but that's precisely what it is - risk. I'm pretty confident the investors in these companies understand the risk, they simply just don't care, because the potential outcome will return their whole fund and some. Do this 10 times and one bet is bound to pay off.

5. I always try to remind entrepreneurs, VCs are finance professionals, not tech professionals. While some may have made their way into VC because of their previous technical ability, there are also many who do not. And just like when you stop coding for 6 months and get "rusty", so do previously technical able VCs who get older and out of touch.

I would hardly consider "spray and pray" to be a "professional" approach to investing, although this aligns perfectly with my experience with many VC firms. The key skill there is sales ability with the types of investor that also allocate large amounts of other people's capital on the basis of gut feels and lunches at expensive eateries.

Ok, I'll be more diplomatic - not spray and pray, but a "portfolio approach".

Hah.

I think you're off a bit though. There is a place for diligence at early VC stage, but it is almost entirely about the people.

That's not necessarily a technology due diligence then...

Fair, it's more of a technical (and other) competence DD

I'd argue (if provided with beer and a forum) that it is a very professional approach once you acknowledge that once you have applied a pretty low bar BS filter, the average, and probably great VC, has no better way of predicting massive success than a crap flinging monkey. Oh, coupled with the fact that almost all VC returns come from the gigantic winners.

It's surprisingly hard to beat random investing. The problem is analysis costs money and having less money lowers your odds. On top of that the classic VC's 2/20 can make money even if the fund loses money creating a huge bias to just pick something.

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.

Wall-street/VC's is focused on convincing people and well funded organizations to part with their money. Thus they need to be able to talk up their choices. Even if it's just "we only employ people from MIT and Harvard so can trust us." But, everyone does that so they really want to be able to say: "I had the foresight to invest in Google so you should trust my judgement."

That said, they could also just randomly choose without telling anyone and justify actions after the fact. But, as you might guess nobody who does that is going to say they did it that way.

The basic problem is if your going to randomly pick then why should I pay you anything?

PS: One fund did chose to fund every YC company which is close to a random choice.

Just to throw something back to your question: Because you showed that randomized investing is a net win, and that your randomization methods are robust. Of course I'm still very curious if this is the case about randomized investing being a net win (though my instinct is that investing in startups is no different than investing in the stock market, and therefore at least as good as randomly investing, because no one has a crystal ball). But if you can just literally show people the numbers... "Hey, put $50k in the pot, X years later, you get $85k out." Or whatever, of course. I just think it would be worthwhile -- seeing that the government already does invest in the stock market -- for the same to feed startups.

As someone else said, you want some vetting to avoid obvious scams. But, in terms of picking the 'best' 5 out of 10 when it's going to take a lot of effort.

Alternatively, a common approach when getting a lot of applications is to simply randomly look at half and ignore the other half unless you can't find enough good options.

So, in the real world you would be able to talk up various points. However, I don't think you can convince a politician to use your random methods unless he can sneak a few choices in.

Random selection might work right now, because all the candidates are pretty good. But, if you announce that you are selecting randomly, it screws up the incentives. If everyone knows that you are selecting randomly, people will apply without any thought or skill, just to pay themselves a salary for a few years.

Well, I'm not saying give the money to anyone who can fill out a form. Just because it's run by the government, doesn't mean it has to be completely inefficient or only feed abuse of the system. Banks have people that look over small business loan applications. There's no reason you couldn't hire someone just like that to work the door to the startup investment club.

I imagine people already apply without any thought or skill, due to the Dunning–Kruger effect.

Beating random doesn't mean making a return. A lot of VC plainly and simply lose money.

This happened! In Nigeria, of all places.

http://www.npr.org/sections/money/2016/05/20/478883658/episo...

I had a listen to that. It was interesting but not really investing, more just giving grants without asking for a return. It seemed to work for job creation though http://chrisblattman.com/2015/09/24/is-this-the-most-effecti...

Interesting points.

So, we're roughly in the same line of business only the customer relationships are reversed (10% PE, 90% VC).

What I'm writing here is from a European perspective.

(1) strongly agreed

> (2) If you're a VC, and especially an early stage one, then no, due diligence isn't necessary.

I don't agree with that, not because it is 'bad for business' but because not doing tech DD at all will dramatically increase the number of bad investments. And with the size of A rounds at the moment it will not take a whole lot of those to materially impact fund performance.

Some due diligence is required, at almost every level of investment, and the easiest way to get to that is to take some minimum amount or a percentage out of the budget to be invested and to use that for a check just prior to actually investing. The bigger the investment, the more complete the process will have to be. Especially when LPs money is on the line.

The reason why this is important is not because the money will kill you after a few bad investments. That's a really important reason, but not the only one and in my opinion not the most important one.

Bad investments eat up partner time. That's the one thing a VC is hard pressed to make more of. More money is usually easily found if that is what is needed to fix something. But partner time is a limited asset and it does not take a large number of flakey companies to significantly impact the ability of a fund to do further investments and to eventually make the fund an underperformer. It can even impact later funds. So the fewer the number of bad investments/time consuming investments the better for a fund.

Early stage (A rounds) require a bit of work, but even at the angel/seed stage it's worth it to take a (very short!) look at the tech to make sure the people involved know what they're doing and that there is no fundamental flaw.

Obviously this should not turn into a full blown DD and legal and financial are a waste of time. But a quick once-over can help weed out the bad stuff.

(3) Strongly agreed.

And I'd like to add security to your list as well as some review of how they got where they are as well as general team quality. I've seen some pretty horrific stuff over the years in this respect (CEOs and CTOs that had absolutely no idea of what their job entailed).

(4) I still wonder what the story is there.

Spot on that it is all about risk, but the multipliers in the US being what they are you're allowed to take more risk there than in the EU, where the multipliers are structurally lower.

(5) I don't see it your way. Some of the VCs that I work with have 'rusty old guys' who are also the sharpest tacks when it comes to identifying the real issues underlying a problem. All that experience counts for something and even if the tech changes the lessons learned remain.

Of course, being one of those 'rusty old guys' myself that could be a biased view ;)

> So, we're roughly in the same line of business only the customer relationships are reversed (10% PE, 90% VC).

Cool, let's merge and take over everything then :)

> (2) If you're a VC, and especially an early stage one, then no, due diligence isn't necessary.

Sorry, I shouldn't have been so blanket with that statement (and you could probably tell, I'm a proponent of doing diligence regardless). If you're an angel investor and doing $10-25k deals then I would comfortably say it might be a waste of time, but if you're doing $1M seed deals, I definitely agree with your viewpoint.

> All that experience counts for something and even if the tech changes the lessons learned remain.

I don't disagree. My point here rather is that many people (i.e. entrepreneurs) see VCs as these more-than-mortal tech gods, which in reality, they are probably more fallible then you and I.

> Cool, let's merge and take over everything then :)

Deal.

> My point here rather is that many people (i.e. entrepreneurs) see VCs as these more-than-mortal tech gods, which in reality, they are probably more fallible then you and I.

Oh, that I'll happily agree with. They are - as a rule - more banker or record label than tech gods and they're certainly not more than mortal. All human failings present and accounted for.

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