Is Venture Capital Worth the Risk? | Hacker News Reader

Is Venture Capital Worth the Risk?

newyorker.com

103 pointsimartin2k62 comments

In short, this article can be summarized: "VC used to fund R&D-heavy startups like Genentech and Intel, now it's used to make startups grow as fast as possible at any cost, just like cancer". Mostly agree with this.

For greenfield plays, the benefits of being market leader are so extreme that "grow as fast as possible" is almost always the right strategy.

Benefit to whom?

There are at least 3 parties involved in every VC funded startup, the company, the investors and the customers.

Growing as fast a possbile and becoming a market leader benefits 1 perhaps 2 of those. I would argue usually benefits 1.

I think it’s hard to argue growing fast doesn’t benefit customers. Becoming a market leader means almost by definition that a lot of customers are convinced you’re selling the best thing on the market.

From another perspective, becoming the market leader might mean that a lot of consumers are convinced you’re selling the best thing on the market because you’re the only thing on the market because you bankrupted all the other choices. The venture capital growth-at-all-costs model results in monopoly or near-monopoly conditions, which is horrible for consumers. If your business doesn’t have competition, you’re probably hurting your customers.

I suppose I can imagine the scenario, but have any VC-backed companies actually grown big in that way? Doordash is the closest example I can think of, but unless you're considering restaurants rather than end users as their customers, it seems pretty uncontroversial to say that it's been good for customers. Alternatives exist, and both Doordash and the alternatives have significantly expanded the range of foods most people can get delivered.

uber's model is/was essentially putting their competition (taxis) out of business with VC subsidized rides.

Taxis are still in business in every city I’m personally familiar with. Are there other cities where they’re gone?

Medium comes to mind, who quickly gained popularity but then introduced user-hostile features when they realized they needed to tighten their business model. Evernote is a similar example. Even Facebook/Instagram/Google before they had advertising.

Having a finite VC-funded runway means eventually having to convert market share to profitability, such as by raising prices, and that’s not always a great result for customers.

Or it means that you're selling $2 of goods and services for $1 of cost to the customer. In traditional markets, this kind of predatory pricing was considered a form of anti-competitive behaviour, but usually only large near-monopolies with deep pockets had the money to pull it off. VC allows a startup - that can't possibly be considered a monopoly - to price a product/service at below-cost for years to grow its user base regardless of ultimate sustainability. See also: Groupon, Movie Pass, WeWork, and maybe Uber.

In the end it's often the VCs that choose the market leader, not the customers. Competitors that enter the market without VC backing are forced to be profitable from the start and have no way to compete on quality or price. This is especially apparent with "gig economy" startups where offering subsidies/incentives to the service providers increases the quality (timeliness, availability, coverage) of the service for the customer.

In many ways it resembles a command economy, with a small number of VCs deciding what "the next big thing" is ("oh, looks like everybody wants scooters, let's pour all our capital into scooter companies").

It's because software is primarily a means of rent-extraction on existing industries than providing massive amounts of new value, with the potential exception of cases where inferential computing is being used.

The market thinks it needs more software when what it needs is good software in the right place. But then the belief that an industry needs more software creates a problem – a lack of software. This comes with the host of other software-specific intractables which spurs on the growth of software-focused labor.

But in the process of converting an industry into one that is software dependent, you can capture massive market-share while gaining slightly greater efficiencies on the services provided by that industry but then introducing a whole new host of software-specific problems. Which grows software's demand.

The thesis that payoffs for VCs are so substantial in software startups come specifically from the scaling of software across an industry capturing industry-specific assets rather than improving the productivity of that industry per se. If it were just about outsized productivity more specific bets that resulted in critical efficiency improvements would be more common. But instead we see broad-based bets that serve to get rid of minor consumer inconveniences, then adding more inconveniences to produce an incentive to raise consumer prices.

> It's because software is primarily a means of rent-extraction on existing industries than providing massive amounts of new value, with the potential exception of cases where inferential computing is being used.

How is software rent-extraction, and why would inferential computing be an exception to this? Software generally reduces the cost of performing some task while increasing speed, accuracy, and efficiency.

> The market thinks it needs more software when what it needs is good software in the right place. But then the belief that an industry needs more software creates a problem – a lack of software. This comes with the host of other software-specific intractables which spurs on the growth of software-focused labor.

Successful companies are looking for ways to increase their margins, which software generally does for the reasons I listed above, not inventing ways to integrate software into their business that serves no purpose.

> But in the process of converting an industry into one that is software dependent, you can capture massive market-share while gaining slightly greater efficiencies on the services provided by that industry but then introducing a whole new host of software-specific problems. Which grows software's demand.

Software generally is able to produce massive efficiency gains, not minor ones.

> The thesis that payoffs for VCs are so substantial in software startups come specifically from the scaling of software across an industry capturing industry-specific assets rather than improving the productivity of that industry per se. If it were just about outsized productivity more specific bets that resulted in critical efficiency improvements would be more common. But instead we see broad-based bets that serve to get rid of minor consumer inconveniences, then adding more inconveniences to produce an incentive to raise consumer prices.

Again, I question why you're saying that software doesn't produce large productivity/efficiency gains, and would add that VCs are interested in software companies because of the high margins, short production cycles, and past successes with software companies (among other reasons). You seem to be focused on a few specific types of companies (I think social media apps would fit your description, though I'd be happy to get specific examples of what you have in mind) that are neither the norm for the software industry or VC ecosystem in my experience.

Eh there are still R&D heavy startups being funded but most of the "growth" in VC has been in less capital-intensive startups.

And this might be a good thing. Lots of the modern VCs, some even by their own admission, don't have the acumen necessary to fund a Genentech or Intel.

So while I'm not happy with the current situation, I don't see the point of scolding VCs for NOT doing things they're not qualified to do.

This kind of begs the question, though: "Then why shouldn't we fire you and hire someone who is qualified?"

Of course, the purpose of VC isn't to fund innovation so much as make money for the LP's, so this really speaks to "What marketing pitches work on LP's?" But at some point they'll get tired of funding Uber vs. Lyft wars and look for a way out of Hobbesian struggle.

I think you answered your question! And it's probably a lot easier to convince an LP to open their purse for the next Uber/Lyft than the next Applied Materials/Lam Research.

Theranos is an example of the dangers of investors that lack the expertise necessary to evaluate "hard problem" startups.

From your summary, I would understand VC to be a case of fractal finance.

It used to exist to fund research-heavy startups, that maybe governments would otherwise have to fund but maybe where governments shouldn't be sticking their paws in (in democratic countries anyway). But now it has become an industry of its own. Just like finance at large.

This article (like most articles about VC) doesn't mention biopharma VCs. Biopharma is the 2nd largest sector of VC after software -- $14B invested in 2019 [0] (disclosure: source is my site) -- and all they do is fund R&D heavy startups like Genentech

[0] https://www.baybridgebio.com/startup_database.html

Everything about this article is designed to elicit outrage.

Why be fooled by that kind of journalism?

It sounds like you just disagree with its contention. I don’t see anything gratuitously provocative here at all.

What point are you trying to make?

Don't waste energy being made angry by journalism that is purposely designed to make you angry?

“Growth for the sake of growth is the ideology of the cancer cell.” —Edward Abbey

Sometimes I wonder why people spend all this energy to bash VC. It's a 4,500 words article and there's only have 5-6 companies to mention as failures of the model in the past decade, compared to the tends of thousands that raised money, and all of those are consumer-facing products.

The New Yorker uses Parse.ly (Venture backed company), GitHub (Venture backed company), BrowserStack (Venture backend company), Asana (Venture backed company), Hipchat (Venture backend company), just to name a few they listed on their Stackshare profile [0] (another venture backed company). I'm sure they are glad those were funded :)

[0] https://stackshare.io/new-yorker/new-yorker

I think you're seeing the issue as a bit too black and white. It's entirely reasonable to think many VCs and VC-backed companies are ostensibly terrible and still buy from the VC-backed companies you don't think are like that.

I agree with you. If you look at some of the examples they mention, like WeWork and Theranos, a lot of the issues there come from founders' questionable practices (or straight up fraud, depending how harsh you want to be). VCs are partially responsible for funding them, but at the same time they are not the ones building the company, and usually don't have high visibility into the day-to-day operations outside of updates the founders send (and board meetings, if they have a seat).

They create the environment that encourages and allows those actions though. If you encourage a rapid growth at all costs mindset, you can't be surprised when outright fraud results.

And if the VCs that funded Theranos had done actual due diligence instead of getting so caught up in FOMO, the whole thing could have never happened.

Theranos wasn't really VC funded. There were angels (whales if you prefer) and corporate but not much VC and certainly no major funds (DFJ being an exception).

https://www.crunchbase.com/organization/theranos#section-fun...

A16Z as a firm took pains to say that it didn't invest and that Sand Hill VCs couldn't diligence Theranos.

https://a16z.com/2020/01/11/16-bio-myths-misconceptions/

But Marc Andreessen himself was a big Holmes fan.

https://www.vanityfair.com/news/2016/05/theranos-silicon-val...

This is the "and yet you use an iPhone" fallacy, except for B2B. https://thenib.com/mister-gotcha/

It is entirely consistent to believe that venture capital is systemically bad despite producing the best companies at the moment. That is, in fact, exactly what the article argues - that the reason venture capital is so dangerous is precisely because it's been so short-term successful despite clear reasons it might not be long-term sustainable, that VC might be squeezing out modestly successful companies because they only get rich from hyper-successful ones.

Of your examples, The New Yorker is probably actually not terribly glad about HipChat, which shut down and redirected its customers to venture-backed Slack, which is growing even more quickly. If this keeps up, venture "capitalism" will be a misnomer - capitalism doesn't work without competition.

Completely anecdotal and subjective, I know:

Personally I try to steer clear of venture-backed startups when I can for the following reasons.

The first is out of fear of the dreaded announcement about the exciting next steps for the team because they got acquired yay (which typically translates to either the product I was relying on being shut down, merged into a shitty bigger product and/or my data being used by Big Co which is possibly what I was trying to avoid by using a small companies product in the first place. Basically, a service provider being acquired has never translated to a positive to me the customer in my personal experience). Especially if the company gets bought by google: now I can look forward to both having my data taken by google (something I’m going to great lengths to minimise!) and an above average chance of the product getting cancelled.

The second is the pressure to make the big return on investment (not just sustainable profit), which in consumer products usually means advertisement and in b2b often means aggressive analytics.

Finally, if the company wasn’t successful enough fast enough it often gets shut down.

Either way, the business pressures usually mean it ends up negative for me, the customer.

Exactly how (typically venture backed) cyber vendors for the financial vertical evolved over the last 10 years.

At one place I worked with a lot of customers' data, I floated the idea of adding a clause in the standard customer contract that an acquirer would only be able to use customers' data to continue to offer the service. I didn't push hard enough for it to be rejected, but this wasn't usually a dealbreaker for customers.

> dreaded announcement about the exciting next steps for the team because they got acquired

This announcement usually means it was an acquihire, and the company was already dead, so you have to stop using the product either way.

Right, but if they didn’t focus on hyper growth because of VC pressure and focused on sustainability instead, then it wouldn’t be a problem.

I imagine the New Yorker's writing staff has vanishingly little influence over the tech stack their dev team chooses.

I think the point is that these are good tools to use anyway. So VC companies have produced lots of valuable companies and products.

Are there any good guides on how to take VC funding but not lose your majority stake or control in your company?

How can you raise multiple rounds but still come out like Zuckerberg? He still returned a lot to investors without ceding control to the board.

Has VC plugged those holes?

The actual How of doing it is not an issue. The question is whether you have the leverage to do it and still get funded.

Any decent lawyer can setup voting and non voting stock, giving founders guarantees of control even if they lose a majority of ownership. Similarly you can award yourself stock at each round. But VCs are not fools. Either your product is amazing and they really believe in you (and will accept no control and possible dilution). Or they don't and you will have to cede at least some control to get funding.

Grow really fast. It’s fairly one-dimensional: if you are growing at +50% month/month, then you will be able to raise substantial rounds with minimal dilution.

If you are not posting exponential growth, then you will likely give up more and more control with each subsequent round.

Do you need to raise fast, then?

This is question of salesmanship and negotiation rather than "technique", no?

Well, there are several available options, as follows:

1. Bootstrap first, then raise one or more VC rounds.

2. Go typical VC route (angel/pre-seed/seed, Series A, etc.), but skip a round or, better, two.

3. Establish a multi-class equity structure, where a) founders are issued equity with increased voting power (typically, 10+ votes per share vs. 1 vote per share for common [and sometimes even preferred] shares) or b) founders' equity has voting power, while common shares have zero voting power (more often used for crowdfunding and Reg D private offerings). There is an extensive debate on advantages, disadvantages and ethical aspects of this approach.

4. Use alternative funding approaches (e.g., SMB loans, asset-based lending and revenue-based lending).

P.S. Hi from ATL! :-)

Hi neighbor, thanks for the info! These all sound quite sensible for certain types of companies.

I've got a CapEx/research heavy project that I'm a bit anxious about funding myself, so I'm trying to sell some lower hanging fruit first.

Are you working on a startup here? :)

Hi there, it's my pleasure! Happy to help.

While each of the approaches that I mentioned above is best suitable for certain types of companies (and circumstances), the list as a whole is generic and comprehensive enough.

Re: CapEx/research-heavy projects -- Interestingly enough, I'm in a pretty much the same situation, as I'm working on my science-focused startup (currently as a side project) and using the same framework for deciding between potential funding approaches. Perhaps, we should talk in private and exchange our thoughts and experiences as well as maybe consider some collaboration (especially in case if you decide to abandon your idea) - your skillset and interests are potentially a good match. :-)

Feel free to reach me at aleksandr dot blekh at Gmail service.

I have a different take on VC and what it means. It's one of the reasons I'm where I'm at in my career. VC-backed companies are worse for employee and the technology community, because they'll optimize the use of open-source software but not the giving back. So your career in a VC backed company (at least in Ops) is mostly cobbling together multiple disparate open source projects into something that "works", but you're restricted from sharing your work publicly to give back to the community.

Contrasting that with large public companies or small bootstrapped companies, both have been much more willing to allow me to open-source my work or contribute to existing projects in a public way. I'm very happy to work for a bootstrapped small company that only produces 100% pure open-source software these days. Something which was always out of reach when I was bouncing between VC-backed startups.

very noticeable change in Silicon Valley culture pre-2007 and post-2008 on this topic ; it appeared that there used to be a detectable, "moral" element to FOSS contributions by stakeholders, but post-2008, pure ROI drives have changed that argument .. they stay silent, don't communicate and don't reciprocate.. Apple Inc, who always was in that direction anyway, embraced the change and stopped pretending to give back, too.

"Is having money better than not having money?"

There are multiple possible funding models for technology companies. VC is not the only way for “having money.”

It can be, if your product has enough VC-funded competitors. The article specifically makes this point.

Such as?

Bootstrap, private equity, angel/friends+family investment

In the article it says 80 percent of the investments fail. If you can have that risk, I genuinely don't see the problem.

Heck for my personal angel investments I use 95 percent will fail. Yes it's risky, but the entire point was to find something that returns in the hundreds of percents rather than 7%.

The math works out.

I only worry about evil businesses getting this VC money or uneducated people making bad decisions on investments.

Thousands of percents, right? If your 5% successes do not return at least 20x, you're globally in the red.

7% is the usual figure quoted for annualized stock market returns, so I guess that’s what they mean: xyz% annualized.

Parent was referring to the “hundreds” part, not the 7. If 5% of your bets win, but only pay off in the hundreds %, you’re going bankrupt. You need at least 2000% return, amortised over the winners, to break even. More to beat that 7%.

Yes, but the point being that 7% is an annualized number; if the hundreds of percent is also referring to annualized returns, then it makes sense.

Genuinely curious how this works for an angel investor if the failure rate is 95%. How many companies do you have to invest in in order to spread the risk of that 95%?

Angel investors are not VC funds. They can approach risk very differently. They don't really need to spread the risk or mitigate it if they don't want to. No one is auditing their investments (besides the tax man). The angel investors I spoke to when I was running my last startup really didn't need to make a profit. They wanted to make a profit because that meant success for a business they thought should exist (and would use in their other businesses in my case), but if they didn't they've only lost some money that they could afford to lose.

I get that but, how much money do angel investors have? How long before the 95% failure rate drains their capital?

You'd need at least 20 investments to even think about maybe beating that 95% failure rate, that seems like a very high number of investments for one person to find, evaluate, fund and wait before the 95% catches up to you.

You don't need 20 before it's more likely than not that you get a success. And I'm doubtful that the majority of angel investors actual have a net positive return.

Most angle investors are either about to lose their shirt, or very lucky or very smart (it's hard to tell the difference between those last two). They usually can only do a few deals before they're spent out. Then they wait to either get 100 times their money or nothing.

They're sort of like guys buying lottery tickets, except the ticket costs more than most houses.

Vc Funds are plying the same game but on an industrial scale. So they get more average returns. Maybe better on average but maybe not for their investors as fees eat into that.

An angle with very deep pockets is probably more like a mini VC fund than an angle. They'll hire people to find and vet investments and maybe pool capital to spread costs and risks.

> uneducated people making bad decisions on investments

Generally, you have to be an accredited investor to invest in a VC fund, and funds aren't really allowed to advertise, so it's not easily available to most people. The post-2008 JOBS Act made it easier to regular investors to angel-invest, but I haven't heard tons of popping up from it yet.

I'm more worried about pension funds investing in PE and VC.

> In the article it says 80 percent of the investments fail

No, the article claims that if 80% fail (but define failure: zero return? 1x?), the other 20% must return 30x in order for the fund as a whole to return 20%. Then it goes on to say that the average fund over 2 decades only broke even. This means that the successful 20% aren't returning the requisite 30x.

> the entire point was to find something that returns in the hundreds of percents rather than 7%.

Right, and if you don't find that something, the fund doesn't work. Funds aren't finding those somethings.

>> A chastening study by the Ewing Marion Kauffman Foundation in 2012 found that the average venture-capital fund in the previous two decades, far from delivering its promised returns, had scarcely broken even.

The paper cited is here: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2053258

VC are selling to LPs the same thing that VC-funded startups are selling to their employees.

> I only worry about evil businesses getting this VC money

And not about the other point they make in the article? :

>> if your rivals are growing wildly at an early stage, and with good hookups, you’re obliged to play the game in order to keep up.

VC is forcing companies that would otherwise be viable bootstrapped businesses, to fail. Then the VC-backed companies fail as well, and everyone is the poorer for it.

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