98% of VCs Aren’t Dumb
bothsidesofthetable.com
bothsidesofthetable.com
Somebody said:
As a former investor, an entrepreneur that thinks he/she understands my business better than I do is a big red flag.
and I replied:
As an entrepreneur, an investor that thinks he/she understands my business better than I do is a big red flag.
To me, this gets to (or near) the heart of the thing. If you're a VC / angel, you're probably fairly smart, probably well connected, and probably have a modest amount of interesting experience in many things. But if you're not one of the VC / angel types who came from a background as an entrepreneur, why should I believe that you have much knowledge that will be specifically relevant to my business. And why should I think you are particularly well suited to judge my business?
msuster, sgblank, pg, and a few others, I would put a lot of faith in, based on their backgrounds... but most other VCs, I really wouldn't be looking to them for much besides: A. money and B. introductions / referrals. I almost certainly wouldn't be looking for product advice or marketing strategy, etc. from them (unless they had some proven background in that area).
I still have my doubts about how much the gain from that experience, that will lend value to any specific future potential investment, unless the firm that failed was in a very similar business. And you also have to consider that VCs frequently sit on multiple boards, and have routine "vc firm dealflow" stuff to deal with, so their attention gets spread around a lot.
Anyway, I don't mean to say that they don't have anything of value to add. But I will stand by saying "you claiming to be an expert in my business is a red-flag", barring some specific evidence to the contrary.
Instinctively I think "should be operators", but when I look at the backgrounds of the VCs I like the best, a lot of them were not operators, or were operators of pretty bullshit businesses in comparison to their VC careers.
1) The 2% who make most of the returns is not consistent from year to year.
2) A VC who underperforms the market isn't a loser, because he's still collecting his paycheck (maybe with a smaller bonus than otherwise).
The combination of 1 and 2 is why the "98%" can keep raising capital, and is the open secret of the professional investment management industry. You can see the same trends in say hedge funds or other actively managed investment funds.
The crazy thing is that KPCB used to be in that set and then essentially voluntarily abdicated to do cleantech crap.
A16Z came from nowhere to join that set pretty much as they launched.
The others (greylock, sequoia, benchmark, accel, etc) are pretty static.
Interesting (and fairly recent) analysis of VCs from the point of view of a limited partner with investments in a range of VC firms: http://www.kauffman.org/uploadedFiles/vc-enemy-is-us-report.....
The mediocre return of VCs also says something about Silicon Valley. The idea of venture-capital funded startups as some exceptional economic engine is probably a myth. There is a lot of economic activity in Silicon Valley, no doubt, but you have to distinguish between expenditure of capital and return on capital. $20 million spent on a startup that never ends up making much revenue is not a net gain to the economy even if it shows up as economic activity. It's just expenditure of capital. So the success of specific VCs aside, the way to measure the economic contribution of VC-funded startups is by looking at the return on investment of the sector as a whole. And since that return isn't great, relative to blue-chip companies, that tells us one of two things about the sector:
Either: 1) VCs aren't great at the job of allocating capital to the right places; or 2) VCs are doing the best job they can, and its just inherently difficult to separate the winners from the losers when it comes to startups.
My gut feeling is that the answer is (2), which implies that the nature of the industry is such that it's so hard to separate the winners from the losers that the gain from the exceptional success of the winners is largely offset by the cost of funding the losers, which makes the economic returns from the industry as a whole unexceptional compared to the returns from traditional blue chip companies.
If SF VC funding were somehow constrained to $1b/yr, you'd get crazy percentage returns, since either only the top deals would get funded, or they'd be funded at super-favorable valuations (allowing more deals on the same money).
Seed and maybe A are not capital intensive, and are probably constrained by great ideas, founding teams, and early entrepreneurial employees. But I don't think VC is the right way to finance lower risk later stage stuff; the public markets could do a good job, and it would be a lot easier for risk-seeking investors (individuals or institutions) to get in and out of investments vs. being LPs in funds, and with lower overhead.
Turn it around, to cash out, is your objective an IPO or acquisition by another company?
Further, the sharp decrease in VC returns means less in the pockets of founders and early employees, and therefore less smart money in the game. Heck, you mentioned Elon Musk's Tesla and SpaceX, his money to get them going comes from PayPal, which was bought by eBay in 2002 (by then it was already getting very bad---granted, that was when the dot.com and post/911 crash was playing out---but SarBox is generally viewed as the last nail in the coffin).
1) Big non-US market growing up (probably in Asia, but possibly in cypherspace), with more rational regulations
2) Massive slowdown in tech progress (which one might argue is underway, but not as obvious; if it accelerates, it will be obvious)
3) Some way for PE to take over from public markets. Content to sit on revenue-generating companies throwing off cash. This already seems to be happening; I'm not sure what the tax consequences are, but I suspect they're smart/powerful enough to either financial engineer or politically engineer a solution.
All of them suck for different seasons. #2 is probably the worst for me personally.
Considering that climate change already kills 150,000 people per year [1], and that this rate will continue to (dramatically) increase, I think it's pretty rude for you to belittle the few good people who choose to fund cleantech (putting their fellow man above short-term economic "rationality").
Cleantech/greentech was originally defined as "non-energy", because energy had a long history of being investable. Energy efficiency and generation is a great sector for investment (I am so excited about Bloom Energy and Lightsail and FLiBe). I'm not at all excited about most of the ex-energy investments, and it appears most of those have failed to the extent that people consider energy part of cleantech now.
They were crap as investments, and most of the non-energy investments had bad science too, as well as being badly managed.
I'm totally pro-environment and pro-efficiency.
In the specific case of KPCB, they did a pretty horrible job with a lot of their portfolio. Missing Tesla and taking Fiskar was a great example. They did get Bloom. But I don't think they were approaching the sector with the kind of scientific and business rigor they used in the past for their other investments, and they were punished for it.
P.s. there is a time and place where big time capital is necessary to start but most of those businesses aren't reading HN.
This is our mindset. We definitely plan to be big (real big) but we're patient and we don't have to paint ourselves into a corner or take any bad deals by trying to do it all at once.
That's not to say that it wouldn't be nice to have more capital to work with, and that's not even to say that we won't ever take VC money. But if we do take VC money, the goal is to do it when we are well positioned to get more favorable terms.
Where else can you charge 2 and 20 for long-term returns below the far less risky small cap index funds?
http://www.kauffman.org/uploadedFiles/vc-enemy-is-us-report....
The other important point is that the 2/98 split is largely exaggerated but you could make it 10/90 and the point would remain valid.
It's sad that all VCs want to be "entrepreneur-friendly" publicly (largely to widen dealflow) but are largely the opposite behind closed doors.
I'd generally prefer to get investment from people whose judgement has proven they know how to get a good return on an investment, because founders typically get the same "return" from that stage on.
"All hedge funds are smart. Period. End of story. Whenever you can gamble with other people's money and get paid on the wins and eat none of the losses, that's the real win. Anything after that is gravy."
[edited in honor of grammar nazis]
How do you become a 2% VC? You have to have been a successful startup founder before. Otherwise, you just don't have the understanding of building the future. The 98% VCs got there from studying business to working at McKinsey, to being an Investment Analyist. Yeah they can do fine by investing in proven startups, that have been done before, but they'll never get their 50x-100x, because they can't predict the future.
So if you haven't been a founder before and you want to be a VC, please quit your job, stop wasting everybody's time and money, start a company, and come back as Gandalf the White.
Their problem is that they're ill-equipped to make the judgments necessary to solve half the problem. They know business and acquisition structures and legal pitfalls, but in order to really get signal on the judgment of people-- I'm ignoring the judgment of ideas because I don't think anyone has that down-- they need to hire someone like me to vet technical choices, talent strategy, culture, etc. because an iPhone app is not going to give them that kind of data.
How do you find that kind of person if you're not that kind of person? I think it's almost impossible. How are they going to tell the people like me from the many who claim they are? Likewise, I'd be incapable of vetting them for whether they're good at their jobs for the exact same reason. I'm not superior to them in any way; we just excel at different things and it's very hard for one side to judge the other.
Perhaps the best way to start a venture fund is to have the selection made not by permanent VCs judging "the team" but by top-notch programmers who do the vetting part-time (no more than 10 hours per week). That way, they don't lose their technical touch and can tell based on technical choices whether a company has a future. (How would a VC know that a company running a typical enterprise Java stack is doomed? It's not his job.)
By the way, the reason VC-istan sucks is not that VCs are evil or stupid people, because they're not. It's that humans are bad judges of character and VCs are no exception. When you can't judge expertise (and they can't evaluate technical expertise) you miss out on the associated proof-of-work and default to social polish, which means that you're going from a slightly positive correlation to what really matters (character) to a slightly negative one. VC-istan generates some awful startups, but not because VCs are bad people.
0) VCs with technical/operating background. I'd put a lot of faith in e.g. pmarca's evaluation of a team. 1) EIRs 2) Outside advisors 3) Portfolio companies (you do some pre-screening, then have your existing portfolio CEOs meet with the founders of non-competitive new ventures. It's win/win, because the portfolio companies may have some useful business relationship, or if the founders can't raise, might be a good hire.
They pick advisors who know how to do what they already know how to do, to validate their decisions. That leads to some improvement in the process, but they're not picking people who complement their skill sets. They're picking less shiny versions of themselves.
I've seen the quality of people who get EIR roles. They're not slouches, but I could do better than most of them, and that includes the ones at top firms. I can actually detect things like what kind of programmers your tech stack will attract; non-technical executives are better with general-purpose marketing, but the 10X factor with regard to programming talent is black-magic to them.
Even rarer than 10X programmers are people with enough experience and insight to know what brings "10X" into being and what smothers it. It's not just about the people; conditions and configuration play a gigantic role.
I've avoided exploring the VC route (as in, becoming one) because I want to keep my technical skills intact. Also, I'd be +5 sigma great at one part of it (evaluating technical choices and judging talent) but I have no idea if I'd be any good at the other (also critical) aspects of the business. I also feel like if I committed full-time to nontechnical stuff, I'd lose that +5 sigma edge. Right now, I know that if you're using Clojure and your competition is setting up the Java/Maven/IDE environment, you'll almost certainly win. I might not be able to pick that sort of thing out, in 20 years, if I step away from using technology on a day-to-day basis.
Right now, I could grep a codebase and tell you better than almost anyone out there if a company has the technical mettle it needs. ("Visitor" or "AbstractFactory" = bad, "mapcat" or "flatMap" = good.) I wouldn't have that if I sat out of the technical game for 20 years, because the signs and terms would be different.
But yes, a less-bitter version of you might be a good EIR, although I think it usually comes from "founder of a company funded by the firm has a midsize exit", not out of the blue.
Three of my friends were EIRs, and two are now founders of great companies (although not hardcore tech companies). The other has run off to Spain for a while, after ~15 years of doing startups, for something of a sabbatical. They're all at the "code for days straight", graduated from top engineering programs (in contexts like being in India or ~20 years ago where that mattered, unlike the US today), etc.
The whole point of EIR is that it's revolving door -- you do it for a year or two, then go back to startups. It's both a way to take a break, and get exposed to new stuff. You still use some of your tech skills, and often end up working on side projects, so I don't think a year off is going to kill your technical competence.
As for the quality of portfolio company review/advice: one top one sent me to do an interview/etc. with probably the best operating executive in the security industry, one of their portfolio companies. I learned a lot, and decided we should hold off on raising as a result (this was ~2 years ago, about a month after I finished YC).
Being an actual full-time VC probably does hurt your technical skills, and I don't think having just fairly narrow programming or programming tech skills is a useful background for a VC, although "ability to pick winning teams" is essentially the definition of a successful accelerator or seed stage investor (but, on more axes than just "can program well"). Something a bit broader and maybe less deep is good, although in cleantech having postdoc level expertise might make sense. I think I have more than enough security industry experience to be an effective security vc, but not enough in the programming tools space, and somewhere in the middle on deployment/automation/networking tools.
I've talked to VC Principals/Venture Partners who are what I'd consider top-50 domain experts in specific things (payment regulations), and some Partners who are top-500 on networking or certain parts of security.
The other thing is it's usually better to have domain expertise in the founding team than implementation perfection, so at seed, a PHP hacked together piece of crap that works is probably fine, as long as what they're doing 1) has a market 2) is possible. At Series A, they should probably have some competence in the team, and after, sure.
I actually think that a bit of so-called "depressive realism" is in order. Sure, it needs to be tempered with some optimism, but you need at least one guy with the winter-traveler insight and the courage to say, "Groupon for cat food sounds like a terrible idea!" Sadly, people like us are not well-received because we tend to haul out the truth when it's not wanted.
But yes, a less-bitter version of you might be a good EIR, although I think it usually comes from "founder of a company funded by the firm has a midsize exit", not out of the blue.
So you have to be born into the club to have that option? Not surprising.
Like I said, the future's not going to come from the people born into VC connections. I don't know where it's going to start and when, but I'm optimistic enough to believe that Real Technology is coming back. I see it already, but not in the high cost-of-living areas.
"Pay your dues", perhaps, but competent person -> funded (or employee at funded company, or just someone known for doing something awesome) -> EIR, could be 2-4 years.
VCs are probably less stupid about credentials than e.g. Google under Mayer with the "core schools" crap. Maybe less stupid than "core schools" in admittance. I suspect being a Thiel fellowship person, a core developer on a really popular open source project (nginx dude for sure, probably Ver if he wanted to do something in bitcoin on his own, etc.) would be more than adequate. Or YC/500 Startups/etc.
You basically have to play degenerate political games to get investor contact as an employee of a funded startup. It really is a two-class world these days.
My experience is based on what I've seen in New York, but everything I've heard about the Valley is that it's the same. Well-connected douches will always have a competitive advantage over real people. We get our shot when tech becomes uncool/nerdy again and those assholes go back to whatever douche Valhalla they return to.
I've seen other companies with a variety of weirdly dysfunctional ways of treating employees, but what's the Tolstoy quote? "Happy families are all alike; every unhappy family is unhappy in its own way." If you have a decent network in Silicon Valley, and/or are willing/able to bounce once a situation seems bad, it's pretty easy to stay in "Happy families" only.
I don't think Silicon Valley vs. New York has a lot to do with it.
The problem is that when you run into bad people and they ruin your career or steal your future, then good people don't want anything to do with you (or, at least, have you at arms' length, and that gets annoying) so you get a string of more bad people (who are always happy to take advantage of your weakened position).