Do VCs really add value? Founders say sometimes
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In my experience it seems like 75% of VCs are neutral. They try to be helpful, aren’t really, but don’t get in the way, and their cash is green. They can email me two times a day if they want, it won’t help me any more (and will be annoying).
10% are actively harmful. Either they have really bad advice, are a distraction, or try to lead your company down bad paths.
15% are incredibly helpful (maybe the 10% and the 15% should be switched), and you should do whatever it takes to work with them. They can think through problems instantly, see 15 steps ahead, understand where you are and what you should be focusing on, know everyone, and actually put in the work. I’ve been shocked at how helpful some VCs can be in eliminating most of your biggest problems. It’s just rare that happens.
That’s why I’m surprised to see how little “track record” was valued. With few exceptions that’s my #1 consideration when deciding who to take money from, or perhaps #2 begind “reputation.”
The most common (negative) example of this I've seen is when founders sell the VC on the solution, not the problem they're solving.
Everything starts out fine (you have a VC who is really excited to help you build and sell product X, even if they don't really care about problem Y). But then you realise that actually, the market wants you to pivot slightly to product Z to solve the same problem Y.
And that's when the VC pivots from being helpful to harmful.
There are probably multiple other examples of how founders can influence the value-add of their VCs, but that's the big one that springs to my mind. And I bet it accounts for 90% of the 'harmful' instances.
There are so many aspects of my work life that this applies to.
Sometimes product managers will suggestion a solution to a problem instead of presenting the problem. Often times their solution needs work and unless caught early a lot of time gets spent going down the wrong path.
Another time this happens with the whole "xy problem." Where I or a team member have problem X, we come up with solution Y but have trouble implementing it. Then we ask for help with solution Y without knowing that maybe it's not the best solution and what we really should have asked for help with is problem X.
I think we could all do better by thinking more about what problems we're trying to solve rather than being married to our potential solutions to those problems.
It would seem to me the best situation would be a VC who actually has industry experience in your target market. I'm not talking about SaaS experience or hardware/software xp, but connections and experience in the actual industry you are trying to disrupt.
I mean it's great if they can help with product strategy, or technical stuff but.... they're finance people. I feel like setting this expectation might lead to no good.
Isn't there a Glassdoor for VC firms? I would love to use it if there was one! Presume they will need to bootstrap and can't VC funding ;-)
A great architect creates frameworks and structures that enable less-experienced people to be productive as well, while simultaneously making many of the typical errors impossible.
In a typical startup, the "business guy" is responsible for both the business insights, and the actual running of the corporation. On the other side of the fence, the technical finder is responsible for the product ownership and implementation. Both parties would benefit from reflecting on the similarities.
One of the big ones for me was realizing a "business visionary" who can't create a cash flow forecast is about as useful as an enterprise architect who can't code fizz buzz. It's not exactly in the job description, but being useless at the implementation almost always makes you useless at the design too.
It's no surprise founders rank speed highly while investors don't. Find investors who care about speed and you'll find a great partner.
There may be some nuance missing in the slide.[1]
Based on the article's text, that right column should actually be subtitled "what VCs think the founders rank as most important" instead of "important to VCs".
The left side is self-reporting (founder's ranking). But the right side is a "Theory of Mind"[2] exercise (what VCs think founder's ranking would be).
I'm not a VC but it seems to me that that "network/rolodex" should be higher rank than "speed". I wonder if founders rank speed above "rolodex" because many startups' bank accounts are near zero and they can't make payroll next week if the VCs drag their feet. Financial duress scenarios like that during fundraising may make founders overemphasize "speed of a deal" to the detriment of other more important factors.
[1] https://cdn-images-1.medium.com/max/800/0*VvTVys39uVMHqtbZ
One way to think about it is in terms of a graph of number of VCs they have to think about/deal with at once. They're going to start the fundraising process with a list of firms, people, etc. Let's say that each week they take on n new items. If it takes 4 weeks to get an answer, they're juggling n*4 balls, many of the conversations in different states. Complexity goes up and/or throughput goes down. It's painful.
I suspect for entrepreneurs speed it also code for clarity, in that the "vc no" (and specifically the "California no" [1]) often present as slowness when it's really about something else inside the VC.
[1] http://ross.typepad.com/blog/2005/04/the_vc_no_and_t.html
The same way we would all like to think hiring is about qualifications and skills, but really it’s almost always more heavily about relationships.
Definitely. Well that, and writing checks.
If you're printing money, live in the United States, and have an IQ of 120 (a bit over 1 std deviation above mean) from a high-tech startup, it should take less than an hour to raise $100,000 seed round on standard terms. Okay, call it a week, even a few weeks or months.
Instead, for 90% of founders who match that description, 1 year of full-time work trying to raise the mentioned seed round would not be sufficient to do so (about 2,000 hours of work). In fact "impossible" may be a good description of the possibility for them to do so.
Without reference to sources, take a guess: how many first financings for startups will have happened in 2018? Let's work through this together, I'll give you some data, you can use it to work on your guess, then I'll reveal the answer.
A good place to start your thinking is that if we take a single academic cohort, say, people graduating college this year, there will be about 2.03 million bachelor's degrees conferred[1]. If we then look at every single year (you can try to raise money any year from when you're 18 to 80), and if we add people who dropped out without an undergraduate degree -- this is true for Bill Gates and Steve Jobs for example -- we might expect, say, around 200,000 seed-stage financings nationally at the very, very lowest-end. On the high end, I'd be pretty shocked if there were 2 million, since that would be 1 out of every 162 people living in the United States receiving seed funding this year (or 0.6%) and not that many people are starting companies every year. As mentioned, that's the number of undergraduates graduating annually. Some more data for you: the number of businesses in the United States less than a year old is around 650,000[2].
Okay, ready? Here is the actual number of startup first financings that will have occurred in 2018: 1,750 [3]
That is less than half of the number of undergraduates who are just right now enrolled at just MIT. [4] Would you fund one of them who just started printing money? How about someone who graduated from there (or dropped out) 4, 5, 6, 7, 8, 9, or 10 years ago? Or from Stanford? Or Harvard? Or UC Berkeley? Or indeed anywhere else where they learned to program and start printing money.
If you're a VC the answer is "No, you wouldn't".
Do these numbers make sense to you?
At the moment I can't raise < $150K with paper millionaire cofounders. I can't get a term sheet even at an 80% discount (discount I offered on a safe note). (Okay a VC offered me <$20K for effectively 51% on non-standard terms.).
But I shouldn't be doing that - trying to raise money, I mean. I should be selling cereal: because Airbnb, a technical company that was renting apartments over the Internet, found it easier to sell cereal profitably on national television than to get first financing.[5]
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[1] https://www.quora.com/How-many-students-graduate-college-in-...
[2] https://www.bls.gov/bdm/entrepreneurship/entrepreneurship.ht...
[3] https://imgur.com/a/HZIIY0h (I just counted pixels, the precision is shown by comparing 2007). Reuploaded from: https://www.economist.com/business/2018/06/02/american-tech-...
[4] http://web.mit.edu/facts/faqs.html
[5] http://www.businessinsider.com/how-a-box-of-cereal-and-being...
Only if you agree with the premise that "Venture Capitalists Get Paid Well to Lose Money".[1]
(I don't agree with that conclusion, I just think they're not writing enough checks for their own purposes.)
In that case the right kind of company in 2018 is an AI social media machine learning cloud platform startup, and there's a whole lot fewer than 1000 of those total worldwide due to the simple fact -- and I think you can see the end of this sentence coming -- that I just spouted gibberish.
More seriously, when Airbnb was founded ten years ago it wasn't the right company either, and the only pivot it made is from being a "rent out your apartment to tourists over the Internet" company 9 years ago to a "rent out your apartment to tourists over the Internet" company with 4 million lodging listings in 65,000 cities and 191 countries which has facilitated over 260 million bookings and as of a year ago, closed a $1 billion round at a $31 billion after becoming profitable in 2016.[2] The founders did this by selling cereal.
[1] https://hbr.org/2014/08/venture-capitalists-get-paid-well-to...
[2] https://www.reuters.com/article/us-airbnb-funding-idUSKBN16G...
[3] https://imgur.com/a/X6Ncr5E (Source: https://web.archive.org/web/20090601000000*/www.airbnb.com )
My company has a Y2 ARR(!) and revenue target that I think would make a lot of YC companies pretty happy, but we are not a sensible investment for venture capitalists.
If you could close it in an hour how much money would you raise on standard terms and at what valuation? (You can list both as a multiple of any metric you pick - any metric, including unjustified projections if you want - if you don't want to name figures here.) Obviously given what I just shared I'm not a VC.
It's not a moral debate. The portfolio math has to work, and things have to work on a timescale that works for fund LPs. At the end of the day, venture capitalists are simply an adapter cable that plugs small chunks of LP endowments and funds into baskets of companies with an N% chance of exiting >7x within Y years. If your company can't do that, the adapter cable doesn't fit your company.
Small community banks don't really exist anymore, and large banks don't really seem to be funding anything under $10 million nowadays, except mortgages.
for a standard VC, sure. Maybe there's a venture investment philosophy for non-unicorns. [0]
[0] https://sparktoro.com/blog/raised-a-very-unusual-round-of-fu...
VCs aren't demanding 10x successes because they're lazy; they do it because the winners have to pay for the losers. This isn't even a VC-specific pattern; you see it in almost every hits-driven business.
Suppose I had $100 million to spend on literal lottery tickets and my goal was to average a 10% per year return on it across all of my "investments". Mainly I try to find places that haven't paid out a large jackpot yet receive low media coverage, so that I have a positive expected return: then I buy a whole lot of lottery tickets there without alerting my competitors to the fact that the lottery tickets have a positive expected value due to the accumulated jackpot, that people seem unaware of.
Now: if my bank where I'm keeping the $100 million, which is stable and conservative, gives me an offer to purchase a 1-year bond from them that pays 12% should I take it? Will it help me achieve my goal of netting 10% returns?
You may think, "No - because that 12% is not going to pay for the non-winning lottery tickets."
But this is muddy thinking because the 12% is not in the same basket of risks as the lottery ticket purchases. It is simply incorrect thinking to group them together.
So yes, tying some of the money up for a year in a bond that pays 12% will help me make my goal of earning a 10% return, even if my strategy is to earn 10% by buying jackpots.
Of course I can be stupid and blow the $100 million on nationally announced huge jackpots where everyone else knows about it and all my competitors are also buying tickets, so that the expected value of the tickets is actually less than I pay for them. That's before the loss that I take on all the logistics, my office, etc. This is kind of what VC's do. They lose money.
You can characterize it descriptively, but please don't call it a sensible strategy.
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I'm still curious about your answer to how much money you would raise (perhaps expressed as a multiple of something) and at what valuation (again as a multiple of something, even projections if you want), if you could close it in an hour no questions asked. Just to throw this out there, I wouldn't raise $100 million at a $1 billion valuation for example, since I don't have any good use for $100 million. How much would you raise if you could, and at what valuation?
Forget the VC's, they're not in this conversation. We've already established they're in it to live on someone else's dime and lose money ;)
In your hypothetical... if "lottery tickets" are the metaphorical stand in for "unproven startups", what does the bond paying 12% realistically stand for?
There isn't a AAA-rated bond that pays 12%. Or, to generalize further, there isn't an investment vehicle <X> that guarantees to pay VC_hoped_for_returns plus +2%. (In any case, if we're talking about AAA bonds, the LPs can just invest in that themselves without involving VCs as middlemen. E.g. you don't need VCs to buy US Treasuries on your behalf.)
To get higher interest rates that compete with good VC returns, you're getting into junk bond territory. Junk bonds have higher risk for defaults. Junk bonds require more research to assess returns. One could also try to sell the bonds on the bond market before the maturity but either way, you're now back in "lottery ticket" territory for bonds.
You're creating fictitious scenarios that don't have realistic choices.
Whole scenario is totally unrealistic. (Though if I parked $100M in cash at a bank I would not be surprised if it offered me a AAA bond @ 12% for, say, $500K. This will cost them $60K per year or 0.06% of this totally unrealistic principal. Maybe they'd do this to mollify me, I don't know. Point is, if my target is 10% returns then I should accept!)
What the bonds stand for is tptacek's business, which " has a Y2 ARR(!) and revenue target that I think would make a lot of YC companies pretty happy" but is "not a sensible investment for venture capitalists".
well yeah, if someone doesn't want venture funding no VC is going to beat down their door and make them re-do their business plan so they can take an equity investment :)
what I said applies more to companies that do want or need venture capital for their plans. These startups are not getting enough first financing checks.
But this just isn't true. In addition to the fact that companies fail a lot more often than operators recognize, there's the fact that a company winding down after years of solid but unspectacular returns is also a failed investment. Companies don't have to lose product/market fit to "go out of business". All they have to do is fail to compete with the operators other options. Eventually, somebody else will outbid the company for key talent.
Slow-burn companies can keep going for decades before this happens. It's not bad to be a slow-burn company! I've spent most of my career in them! But to take money from LPs, you have to have a story about how you can pay them a return.
When small community banks disappeared (as nikanj points out), who would have financed these "sensible old-school companies with 10% per year growth and 15% profit/revenue ratios", that didn't make them riskier.
Meanwhile your subtext is that you just don't want to raise money. You spent a lot of words pinning it on how it's bad for VC's but all I asked you is what term sheet you'd write for yourself if you closed an hour later. None: you don't want investment. That's fine!
Banks do fund businesses like this, all the time. The difference is that they fund with debt instruments, not equity. You're obligated to pay them back and can't deliberately manage your business to avoid the obligation (chances are, you'll have to co-sign the obligation personally).
If all you're arguing for is broader availability of lines of credit, by all means, keep asking for that. But that's never been what startup investors provided.
In 2018 more than 1,800 startups are fantastic equity investments at a time when they're printing money, and VC's are idiots for writing 1,800 first funding round checks to startups total, nationwide. I couldn't believe how low that number is. You said, "well yeah they're printing money but it's the wrong kind of money". You would have called Airbnb the wrong kind of startup and you would have stood there and told me VC's are totally right not to invest in them. 9 years later here we are, $31B+ valuation.
It couldn't raise its seed round and it's obviously because VC's are idiots who are paid to lose money. It sold cereal on national TV instead. That's a fact.
My original point was just that VC's don't write enough checks. thanks for the exchange.
VC constraints:
1. VC has to get out within a specific timeframe, let's say 10 years and return all money to the LPs.
So VC can't afford to wait indenfinately collecting narrow streams of money.
That leaves you with very limited opportunities.
2. The number of companies they can deal with is small. There is a cost per transaction (funding), fewer transactions you make, better you do. But some transactions are must for VC math to work.
Banks also used to make only big loans in past. Micro lending is a recent thing. Algorithmic underwriting which doesn't even require manually looking at the balance sheet is based on heavy data collection, KPIs made feasable by technology advancement like big data processing etc..
3. VC can't fund anything which doesn't match their investment thesis. The LPs often start fund with a specific mission, for example, "advancement of AI for humanity". The VC partners often are veterans in specific industry and their resources are often useless in other industries.
This further reduces the number of companies they can fund.
4. You seem to assume all VC are chasing returns, well no! If our mission is "AI advancement". It's much better, if we've 2-3 focused winner companies in this niche. Fewer companies achieve better leverage, industry penetration, economies of scale and ofcourse, too big to fail.
5. Most of those small profitable companies are not able to keep stable revenue for 3years+.
One of the most misunderstood thing about VC, is that VC money wants maximum returns.
No! VC is a quest for control over new monopolies with enough holding, VC can influence and install their own management.
Money is cheap for them.
Imagine if you are an engineer and you own the largest semiconductor company. It's established fact that the old monopolies die and new disrupters emerge as new monopolies. You can't change this!
What you can do is control new disrupters by purchasing equity in them.
You do this by starting a VC fund and putting money derived from your semiconductor business in the fund. You can liquidate some of your holding it's not too hard.
Your VC funds thesis then becomes, "semiconductor advancement".
Then GPs will not chase the startups which have nothing to do with the semiconductor as their main focus.
If you don't do this, you watch your semiconductor empire dying. If don't even have stakes in new semiconductor disrupter monopoly, how do you maintain your dominance in this industry? That has a price, so absolute returns do not matter.
When a VC funded company dies, LPs do not cry. They cheer because another potential disrupter died trying, this can explain why some VCs are downright bad as they want you to fail.
Secondly, some VC funds have LPs who get their money from industry underdogs and really are after a disrupter who can unseat the current #1. So, they might be more helpful.
VCs are after potential disrupters.
Now if they want to kill the potential disrupter or help it grow that depends on the people who's money is at stake. No one is really going to share their motives upfront.
I can see you're a new-ish member (created 7 days ago and shown in green), and have stealth in your name, but I reviewed your comments and they're really high-quality. I'd appreciate if you would get in touch with me at my email listed in my profile for some out-of-band followup questions. Thanks for sharing your perspective on HN and welcome again. Very good posts.
Why weren't the institutional investors/LPs surveyed to see what they think of VC/GP value add? I think this would be more telling about who the good/bad VCs are ..... who's bringing home the bacon across the board consistently. A bad VC may do well with one investment, get great feedback from that founder but yet destroy investor capital on all other investments..... meaning the LPs are down on the money they put in.
The Kauffman foundation produced a great study of return performance from VC/GPs back to LPs several years ago. The conclusion was that investing in VCs produced very poor returns. The Russell 2000 index was a superior investment alternative.
They did a study of married (heterosexual, this is an old study) couples and asked them what % of the housework each did. The percentages always added up to over 100%, and in some cases a lot over.
There were many reasons why people attribute their own contributions to be greater than that of others.
This just seems to be the same phenomenon on steroids.
They should ask the founder how helpful the VC is compared to the banker, or the advisor on the board. They should perform other sorts of comparisons to add context.
Consider that VC may be performing functions that are useful but are not properly appreciated, for instance, signalling.
Edit: Also consider the VC contribution of raising money and then staying out of the way.
A few other observations from my 5-6 years so far in VC:
* Founders spend 3000 hours/year focusing on their business and domain while investors spend 3000 hours/year learning about hundreds of business and hundreds of domains. As a result, >95% of the time founders know way more about their specific business than their investors. On the other hand, >95% of the time investors know more than founders about cross-business strategies and ideas. So investor advice is best when it's related to their broader perspective: what kind of recruiting channels work best for the 50 companies they work with? What are tips for negotiating a contract? What are good pricing strategies? How early do companies typically hire a VP of Eng? Most investors won't be helpful for domain-specific questions like "will power plant operators really want this feature in my SaaS product?" or "what's the best marketing channel for reaching power plant operators?"
* Even for a single investor, their helpfulness will vary company to company. My guess is that if you polled the founders I've worked with, 1/3 would say I'm very helpful, 1/3 would say I'm somewhat helpful, and 1/3 would say I haven't helped much. I hope/think none of the founders would say I subtract more than I add. Sometimes it turns out I can help a lot, like if you're looking for a VP of Eng and I know a great candidate who is looking for a job. Other times I can't help at all, like if you want to be introduced to power plant owners and I don't know a single one. I do my best to help when I can and stay out of the way when I can't.
But, the point of “sometimes” is still a valid one. So, be selective if you are looking for someone who will be more than just a check.
For apps, a single person can build a major app in a year.
For products, tooling is often between 50k-1M. Everyone here is a software engineer or similar, so that money isnt hard to make/save.
Can anyone explain? Advice + support is extremely valuable, but I dont quite understand why so many startups go this route.
I believe this is false by at least two orders of magnitude. Particularly if major means high scale, with properly researched and designed to your customer, with proper support for users/customer, with proper infrastructure technically, financially and legally wise.
I am all for bootstrapping business and have as role models the likes of DHH more than VC-funded founders. But that doesn't mean I don't understand the need of capital.
There’s a lot more to running a business than the coding part and these things take time (and sometimes money). The 50k to 1M estimate is greatly inflated by those other concerns.
Plus, while I can save, say, 250k, that would take me years and then I wouldn’t want to risk all of my savings into one gamble (I obviously wouldn’t take the startup risk if I didn’t believe in what I was building but even if I thought it was a sure thing, I’ve founded two failed startups already, it would be prudent to allow for a high chance of failure even if certain that the business is perfect)
Also, let’s assume everything above is irrelevant and I decide to save up my earnings and go all in on a startup. Let’s say I put 250k in and it takes me five years to save (in reality, I don’t think I could do it in that time, but let’s inagine I can). Let’s also assume that I do as much as work during those five years as possible so that when I have the money, I’m ready to launch. That means that five years from now, I can launch my startup, spend the money on whatever is needed that I couldn’t do previously and hopefully not lose it all (assuming the market still exists, 5 years is a long time in tech land). OR I could give up 5–40% of the company, put up with some hassle of having an investor and launch in a year (assuming development takes a year regardless). That gives me four years to make sure that the remaining % is worth more than -250k (which is where I’m at with the first scenario after that time). The investment route seems like a no brainier to me in this case.
Obviously it is possible to bootstrap a company and it should be the preferred route imho if you can pull it off. For many people, this isn’t an option though and that’s why VCs are becessary.
Alternatively, VC interest is both a cheap experiment in market fit and a boost to your brand. Media is more likely to report on your little startup if it's a YC darling and marketing or sales are at least as important as engineering.
Most Americans don't even have a thousand dollars in their bank account.
https://www.cnbc.com/2017/09/13/how-much-americans-at-have-i...
This is just theory to me, as a nonentrepreneur.
Though you still might build it, then find nobody wants it. Now you've wasted a year or more of your life. It happens all the time even with funded companies. You build it and nobody comes... or two few customers to support a real business.
To do something "major", you need people. People want to get paid.
The other reason is that if you have other people invested in it (the VCs) they will also try to help you through things like helping you get contacts etc.
Also, even if you build an app that doesn't mean anything. You need to get some marketing campaign out and you need to make sure you don't violate any laws or regulations. You have to do all of this alone.
It’s about exporting risk.
Not everyone lives in SV.
I'm a potter in the UK, FWIW.
And to ask a different question - can a founder funded by VC money run their startup without giving up their entire life, and a substantial proportion of their potential earnings?
Very different from using all of your resources to self fund it.
POF was a minimalist app in a well trodden market. You shouldn't raise VC to do something like this, and you shouldn't be able to (though yes it happens far too often).
There are many problems and markets that just don't fit this approach.
That's a data point of one, and VCs are dealing with . . . uh, everyone but me. So I'm not making a blanket statement about what value should be. But that's what I would find useful.
This disconnect represents a significant opportunity for new VC firms.
"VCs ranked top 3 criteria they thought the founders evaluated them on."
Then the supporting chart is labelled "most important factors for partnering or making investments"
Which is it? Were VCs asked about what they believe founders value, or what they find important in making investment decisions?
Because the article points out track record is rated low. Which makes sense for the former but makes zero sense for latter, so I'm guessing chart was just mislabelled.
The value they add is called "money". They give you it every single time(you work with them), not sometimes.
If you expect them to babysitter you, mentor or friendship, from my point of view it is your expectations that are wrong.
You should find emotional support elsewhere. I recommend masterminds.
I am friend and colleague of old VCs of mine. But I did not expected from them in the past more than a professional relationship.
This is probably what makes a good friend or a lover , not being too much needy and dependent.
Also not surprising is the that VCs overestimate their value.
Lastly founders probably have a much more diverse (and perhaps incorrect view - probably fostered by the VCs) of actual value add of VCs.
I’ve also seen extremely helpful late stage strategic investors who brought great customer introductions.
My view is that things deteriorate when the CEO ceases to be honest with the investors, or when the investor is out of their natural element.
VCs have the rather different requirements. People looking for their money is an ongoing activity for them, so there is no particular advantage in ending that dance with any particular founder. Indeed, not being in a hurry to make a deal when the other side is improves their bargaining position. (Unless someone else is faster.) And the more likely they are to hear about a showstopper that would make them decide to not invest.
The result is that VCs want to drag negotiations on as long as possible..right until the moment that it is clear that some other VC is leading the investment and their possibility of getting a piece of the action is slipping away.
This is why what YCombinator does works so well. They decide very fast on whether you're in a batch. They standardize terms, which makes it harder for investors to drag their feet. And on demo day, every investor knows that they are competing with other investors in an investment round that will close quickly. This forces them to make a go/no-go decision.
Interestingly, the fact that founders get to raise money quickly and get back to their business improves their businesses odds of survival. Which improves the prospects for investing in them.