= turnoff for investors. They only care for chances at homeruns — singles and doubles are not welcome. You’d better swing for the fences, because that’s the purpose of VC.
(This is my understanding, not my endorsement. Please correct as needed)
VC wants to have a portfolio of 100 companies swinging for the fences, knowing most of them are going to zero.
Individual founders do not want to go to zero, and many would be happy hitting singles or doubles.
That is, VC wants their founders to take more risk than is expected value positive for any given founder. A lot of the legal & financial levers VC uses are to force this upon you as a founder.
The question only seems to be whether this strategy still works in a higher interest rate environment. As I understand it this development mostly stems from it being more profitable to invest with a low ROI (or a low probability of a high ROI) than to keep the money in the bank.
Basically, give me my market returns if you’re not going to hit a homer so that I don’t need to keep shoveling cash and can spend my time and money on the remaining at bats.
Someone working on their $500 MRR form-builder app isn't building a startup, they're "just" building a regular ole business.
Personally I'd much rather build a business than a startup.
It's that singles and doubles aren't profitable for the VC fund.
The VC business model is based on promising investors high return in return for high risk. Typically the fund will take a management fee along the line of 0.5%-2% a year, sometimes frontloaded a bit to account for the higher cost of marketing and finding investment opportunities. 0.5%-2% does not get you rich unless you're a huge fund with very tight operations - it costs money to have people following up a large portfolio. For most smaller funds the management fee will tend towards the lower end, and will just keep the lights on.
Then on top of that you get carry. Carry can vary enormously based on your reputation, and your promises. Specifically, the higher the threshold before the carry kicks in (the hurdle), the more you can insist on retaining above that.
A not untypical example would be to retain 20% of any return over an amortized yearly return of ~7%-15%.
Put another way, in this case $400m of investment was made. The last round was 3 year prior, but much of the capital had been in the company much longer. The VC's in question would, with a 7% hurdle rate need a return of $490m before they'd see any money beyond the management fee if this company was typical of their portfolio and the entire $400m investment was "only" three years old (much of it would have been older).
As such, if the VC funds in question were otherwise successful, a $465m exit would have been dragging their profit down. Not as much as if it'd gone bankrupt, but this was a really bad exit for the VC's, and basically represented the VC's having written the company off as a failure and salvaging what they could before they lost more.
The investors in the VC (the limited partners in the VC fund) would have done better, but keep in mind 7% represents roughly the return of an index fund over time, so for them getting "only" $465m back after it had sat in the VC fund for years will also have represented a significant opportunity cost vs. putting the money in a safer vehicle that might have returned more.
Anyone can get S&P 500 returns with little to no risk. That’s not to say they won’t lose money but it’ll be market returns either way, will be very liquid, and readily transparent to the holder.
Given the risk involved in early stage investment the maths just don’t make sense for an investor to shoot for anything short of the moon.
tldr; Seed funding / early stage investing is closer to lottery tickets and Vegas than to your 401k.
Unless it’s buying SP500 index funds, I doubt it. Especially the last 15 years.
I know quite a few people who would have been further ahead (financially) if they had just invested in SP500 and retired.
I mean literal index funds.
Given the situation described in TFA, that's just as well.