Definitions on the Economics of VC | Hacker News Reader

Definitions on the Economics of VC

a16z.com

99 pointsrunesoerensen22 comments

This is the key takeaway:

> While VC dollars are a significant source of capital for facilitating new business creation, the total capital deployed is remarkably small.

And oddly it gets a disproportional amount of media coverage:

http://avc.com/2016/08/understanding-vcs/

http://www.forbes.com/midas/

I dont think it does - It deploys a small amount of capital, but

>These companies now comprise 38% of all employees, 57% of the total U.S. market capitalization, and account for 82% of all R&D spend — a proxy for further innovation growth — in the United States.

So it seems like it does a disproportionate amount of stuff.

> And oddly it gets a disproportional amount of media coverage

It fits the narrative that if you have the right idea you will be rich with help of the already rich people. It is the American dream were some one bets on you and you get to be the best.

I like documentaries like http://www.indiegamethemovie.com/ were you see how much effort it requires to bring an idea to live. And even that they have chosen successful games, the bast majority never sell a copy, still looks more realistic than the VC stories.

I know two people that made successful games for Steam and iOS. And it required in one case years of development after getting home, in the other to invest the money of their company in the game. And in the end they are not rich, but they got good money out of it.

1. Invent revolutionary product

2. Get VC money

3. Unicorn

It is a story with more impact.

Is it odd?

The vast majority of investments in this world are safe and boring. People like to get excited/infuriated about the risky, semi-shady, gritty startups that ran the gauntlet and the VCs that were clairvoyant (read: lucky?) enough to get in at the ground level.

You can make a compelling story out of a startup/VC success replete with heroes to emulate, lessons to learn, anecdotes of how close the company came to imploding. It's hard to make a story out of the ebb and flow of pension/institutional fund AUM.

https://hbr.org/2014/08/venture-capitalists-get-paid-well-to...

Quoted from the hbr article above:

" 2013 annual industry performance data from Cambridge Associates shows that venture capital continues to underperform the S&P 500, NASDAQ and Russell 2000."

Why institutional investors throw money at VC instead of much better options?

Just because the aggregate of VC firms under perform doesn't mean there are exceptions.

When you invest in market indexes, your gains are relatively capped. There's more volatility in venture capital, but that's the idea - some years you're in the dumps, other times you're investing in Dropbox, AirBnb and Uber, at the same time.

> Now, fast forward to when the fund is over; most funds have a 10-year life with two or three 1-year extension periods. Assume that all of the $140 million in interim marks proved ephemeral and all of the companies that comprised those marks proved to be worth no more than the paper this post was originally written on. In our last example, the fund generated only $60 million in total returns on a fund of $100 million, but the GP distributed $12 million to itself back when the prospects for the fund were looking up. In this case, the GP has over-distributed to itself and is subject to what’s called a “clawback” — the money needs to get returned by the GP to be distributed to the LPs. That sucks, but is fair in that the GP never would have been entitled to that money had it waited to distribute the $60 million until the fund was over.

I find this to be an interesting divergence from a typical hedge fund. For a hedge fund the end of year number is everything.

For instance if you start the year with $100 million in assets and finish the year with $110 million even if none of the gains are realized, then under a 2 and 20 model you keep 2 million for your bonus pool. Next year if you end up down such that you end up back at $100 million you don't give back the previous 2 million in performance fees, that's a completed transaction.

Now some funds have a high water mark, which means you don't earn performance fees again until you get above your previous year end high, but not all funds have such a requirement.

It must be tough for VC funds to pay out bonuses when you can't really claim realized gains until after the entire fund is closed.

I guess this leads to a focus on two things:

1) the management fee to help smooth cash flow over, which means most VC funds probably wont' lower their management fee and additionally this may incentives the VC to try and raise as much as possible, even if this excess capital might be a drag on returns.

This focus on management fees does happen in the hedge fund world, but I know quite a few funds that only take 1% or 0.5% as a management fee and take a larger portion of the gains 30% in return.

2) This benefits established funds as they'll have retained earnings from previous funds to help pay key people for their work on a current fund while its waiting on cashing out its returns. Especially important in today's environment of companies staying private longer.

IIRC, the lead for an angel syndicate can make deal-level carry (as opposed to the fund-level carry that is described here). This leads to some incredible risk-taking: there is no consideration for how they might be harming their "fund-level return" (i.e. the return on all the investments they as an individual have participated in) -- and they don't really care because that isn't their biggest opportunity. The biggest opportunity is the carry they can make on this _one deal_ if it's a home run. So the average angel who is just participating (and not leading) has a really risky portfolio.

http://avc.com/2016/02/fund-level-vs-deal-by-deal-carry/

> Most VC funds entitle the GP to earn a carried interest — a portion of the profits of the fund — of 20%

Unless you are A16Z and then it is 30%

For me I struggle with why, like science spending, there is not more, a lot more, VC funding. It's hardly like there are too few people hanging out shingles.

YC was trying to change the game but I may be missing where the VC industry is throwing money out the windows - except possibly I one small part of a city on the west coast. Or am I looking in the wrong place. The article claims 28bn in new funds, but 3 trillion in hedge funds and world GDP is what 13 trillion? That's about 0.2%. Seems low

That 0.2% is just to get things off the ground and see whether the idea works. Successful ventures just raise money on the normal stock exchange.

Put another way, should we be spending, 5%, or 10% of world GDP annually on risky ventures that probably won't work? Are there really that many untried ideas that need that level of funding?

put it this way, Universal Basic Income is supposed to free humanity up to perform those innovative tasks we always mean tondo but cannot due to the drudgery of work

I naively assume that if we all have tenure, we will see a third of humanities time on art, a third on science and a third on "new businesses". Plus a third on sex...

So mentally I am asking if we were free to choose, why is the delta between 2/3 and 0.2% so huge.

Re: Columbus' voyage as a VC investment - it made me reread an old blog post and chuckle : http://www.mikadosoftware.com/articles/columbus

I'd shy away from Isabella and Columbus . . . murderous, rapacious, relgious fanatic, imperialsist isn't a good look for a VC.

I thought it was a very good example of historical venture capital. Optics aside, if you define venture capital as very high risk, very high reward, the example fits well.

Touché though I didn't say it was a bad example. It's a great example, in an adjacent sense, the autobahn is an excellent expressway system.

Keep in mind that this is the VC that said that they should be able to take back the stock of employees that quit. (obviously that doesn't compare to the horrors of Columbus)

That's amusing considering that the dilution and protection agreements they get for investing severely reduce or zero-out the value of most regular employees' stock anyway (except in the most successful of exits of course).

Wow, can you elaborate? These guys typically paint themselves to be very founder and employee friendly.

https://news.ycombinator.com/item?id=11963551

The firm doth protest too much, methinks.

What are they protesting? This is an informational post.

Reply on news.ycombinator.com