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Comment by citricsquid | Hacker News Reader

> Is your business large enough? Most companies are not large enough to be backed by venture capital. To raise venture capital, companies should be in multibillion-dollar markets or have the potential to make revenues of more than one hundred million dollars a year.

That seems to be a nonsensical and arbitrary figure pulled out of thin air. Let's say hypothetically there's a business that needs $1m to start, the maximum revenue it can make is $50m/year of which $20m is profit. Why shouldn't they raise venture capital? The business would be providing a return for the investors because the business would be making money. Not every company needs to be making billions of dollars to exist.

VCs make their money by investing less in a company than their stake is/will be worth, if they invest $1m for 10% of the company and that company is then making $20m/year profit they have made a worthwhile investment... haven't they?

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It's all based upon the exit. The VCs get diluted along the way and 1 million is the first step down the road. You'll probably raise way more. I believe the average dollars amount raised for tech companies going public this year was 65-70 mil. It's the general rule of thumb to gauge a market. Millennial Media had about 100 mil in rev and went public a few weeks ago at a 2 bil market cap (yes, the multiple was ridic, but let's leave that factor out).

$1m is more in the range of angel investments than VCs. I think angel investors would be very happy with a $20m/year profit company after only $1m investment.

Too early to say. VCs get paid when they can sell their stock, not when the company makes a profit.

Business making money != VCs making money. (Also, VC-backed business making money != founders making money. Your VC probably isn't going to let your company issue a dividend, which is how you'd get those profits out.)

The $100MM is probably a 'minimum revenue to plausibly take the company public and get paid' figure.

So my understanding of raising money is completely wrong, the only part that matters to investors is if the company goes public or is sold?

No, it's not wrong - but as always it's complicated. VC's have a relatively short time horizon within which they need to provide a return to their LP's, and their returns typically are driven by a few outsized successes (>7-10x). Sometimes entire funds can be made because of one mega-hit, and that always seems to be on people's minds when considering cos. Dividends aren't ideal for returning a fund, and investors are often nervous about deals with a capped upside.

VCs just don't do divdends. Why take money out along the way when you can invest it into the company to get a bigger exit?

Not saying VCs dont' think that way, but sometimes throwing money into a company wont have the slightest effect on size of exit.

In the category of 'potentally stupid questions', why can't VCs also make money from dividends?

This is my confusion too. I was under the impression that was the normal way that VCs made their money and companies going public or being sold is the outlying (but most desirable) result.

VCs don't want your dividends, they want you to deploy that capital into growing the company.

At early stages, I can completely understand this.

Consider Craigslist.

Fantastically successful business, makes hundreds of millions of dollars a year using less people than you'd need to run a McDonalds.

Growing this kind of company is not capital-intensive beyond a certain level.

So, should you end up building a Craigslist, why would the VC firm want an exit, rather than a continuous (and large) flow of checks from dividends?

Craigslist is a horrendously mismanaged business. I wouldn't be surprised to see AirBnB dwarf Craigslist soon- that's the kind of company VCs want to invest in, not something like Craigslist that has been stagnating for years.

AirBnB started out by attacking Craigslist as well as the commons. They probably will win; I'm continually disappointed at how eagerly we reward bottom-feeders.

Craig isn't optimizing for profit. He's optimizing for maximum user benefit, and letting the users decide what benefits them the most. Mostly they want free classifieds without paid advertising attached, so that's what he gives them. In a few cases, the users wanted to pay for classifieds, and those users are the only reason Craigslist makes money.

Judging Craigslist by the standards of a profit-seeking business is entirely missing the point.

VCs invest through funds that 'shut down' after a few years so, unlike mutuals fund that exists indefinitely, they have a limited timeframe to make that investment pay off.

VCs have the expectation that most investments will fail, so the only way to return a profit to their investors (LPs) is to have a few really big hits.

For example imagine a VC with a fund that only holds two companies, and has invested $1mm in each. The first has dividend paying 8% (for a total of $80,000) year over year. That wouldn't be bad on its own, but say the other investment lost 75% of its value (or $750k). The overall return for that combined portfolio over a 10 year period would be pretty poor.

The real value would be if one of those investments of $1mm in equity turned into $20mm in equity over the 10 years through an acquisition or IPO. If that were the case, a dividend of 8% would be very small in comparison.

Not a stupid question, but it isn't their model. Some reasons why it isn't their model:

a) The primary customer of a VC firm is not an entrepreneur. Rather, it is a limited partner: a personal (natural or otherwise) who has tens of millions of dollars allocated out of a larger pile of hundreds of millions specifically for a bucket called Risk Capital in their portfolio allocation strategy. Their only mission for that money is Go Big Or Go Home: they're interested in assets which reliably pay 5% per year but NOT FROM THAT BUCKET. For that bucket they're looking for 20%+ a year over a 10 year period regardless of what happens in the generic stock market and they're willing to pay two and twenty to make it happen.

b) A VC fund is organized as a 10 year commitment between the VCs and their limited partners, and has to wind up at the end of 10 years. Having large amounts of residual illiquid value in the portfolio, like shares of a private company which pays dividends, are the opposite of a win condition. If you value the future dividend stream annuity-style at, say, $100 million NPV or give the VC the option of an acquisition by Google at $90 million in a later year of the fund, the VC will push for the acquisition every day of the week and twice on Sunday. They need that win before the fund closes and they lose the ability to take their 20% of the winnings from it (and primp it to investors in subsequent funds they may manage).

c) Just a social norm: US tech stocks do not historically pay high dividends -- they typically reinvest into new lines of business, like an office productivity company deciding to successfully remake the domestic videogame industry or unsuccessfully compete with their hated advertising company rival, or a domestic purveyor of status goods with microchips in them deciding to make smaller status goods with microchips in them and become the biggest company ever. There are exceptions -- MSFT pays a modest dividend and once did a gigantic distribution -- but they're largely marginal rather than decisive.

Patrick, sometimes I wonder if there's anything you don't have a deep understanding of. :)

So, in this case, a profitable company might make the case to buy its shares back from the VC at the same price point they would see in with a 'successful' acquisition.

The word you are looking for is opportunity cost. Put simply they have an opportunity to make more money some where else.

However, different investors have different risk profiles and prefrences and that investment may appeal to a certain class of investors.

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