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Comment by pg | Hacker News Reader

VC's can take much bigger advantage of a 25 year old than a 50 year old

This is a persistent myth, but if you examine the math it doesn't work out. A VC firm could improve their returns by at most 2x or 3x by extracting really good terms from an inexperienced founder. But that's rounding error compared to the 100x difference between a big success and a small one.

This is a subset of the more general rule that there is no "value investing" in startups. All the returns are concentrated in a few big hits, and a VC does well iff they invest in them, regardless of the terms.

The empirical evidence confirms this. Google and Facebook are among the biggest recent hits for VCs. Both had young founders. But the reason VCs made so much from these deals is not that they extracted unusually good terms from the founders. In fact, the founders extracted unusually good terms from the VCs. The VCs made a lot despite that, because the companies were so successful.

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OK, so they have a bigger pool of investments to choose from if that pool includes founders who would reject lousy terms. I get that, but it doesn't change the math. VCs can still only invest in so many companies. Perhaps having a 50% larger pool allows them to raise the bar slightly on who they fund, but the difference that makes is still proportional to how well they can pick winners in the first place. That's probably a smaller effect than many other biases to which they're prone, and far smaller than the difference in what they get out of each deal based on the terms. Many small wins or few big ones, "2x is 2x" still seems like the guiding principle for a firm operating alone.

The argument that really seems worth considering, but which wasn't made, is that firms do not operate alone. Offering better terms is a competitive advantage vs. other firms who might vie to fund the same opportunities. Even minor changes such as paying one's own legal bills seem to generate substantial goodwill among entrepreneurs. When there are multiple firms involved, friendlier terms might be good strategy. That still does nothing for founders who struggle to find funding on any terms, though. Cases like those you cite are the exceptions; it's still "race to the bottom" in the common case.

It doesn't do that because most startups fail. Selecting for the ones from which you can extract the best terms just gives you more of the failures. Negotiating strength isn't just a proxy for company strength, it's also an intrinsically important business skill. This is one of the more basic illustrations of "adverse selection" you can find.

I'm sure there are VC firms who do scout out pushover startups and bleed them. But then, most VC firms fail to generate attractive returns.

I challenge you to find statistics showing that any VC favors the tough negotiators over the easy ones, or that there's any correlation (let alone causation) between negotiating strength and future success. Yes, it's an important skill, but negotiating with VCs and negotiating with customers are two different things. That particular subset of negotiating skill pales in comparison to things like having a good vision, hiring good employees, or executing the rest of a business plan well. The world already has too many people whose only skill seems to be schmoozing VCs.

> This is a persistent myth, but if you examine the math it doesn't work out. A VC firm could improve their returns by at most 2x or 3x by extracting really good terms from an inexperienced founder. But that's rounding error compared to the 100x difference between a big success and a small one.

Can you explain this? If by some method you can get overall 2x the returns, why does it matter that most of the income is in the big hits? 2x is 2x regardless.

You could've put your money in a company that made 200x instead. (VC's don't have unlimited capital.)

The point pg is making is that it's not an averages game, it's a lottery game.

Say there are two different people playing the lottery. Every day they buy a number of tickets. Person A buys tickets in a pool along with someone else. Person B buys tickets on their own. Thus, if Person A wins the lottery they'll have to split their winnings, whereas Person B gets to keep it all.

OK, so who ends up being better off? The answer to that is entirely decoupled from their share of the lottery winnings, what matters is entirely whether or not they won the lottery. In terms of VC financing, the RoI from "winning the lottery" by hitching your horse to a small company that grows until a multi-billion dollar enterprise in a few years is going to dwarf any other aspect of investing and returns. Thus it's vastly more important to ensure that you are doing everything possible to maximize "winning the lottery" rather than trying to maximize the share of the prize you'll get. 2x or 3x may seem like a lot, but it's nothing compared to the 100x, 1000x, or 10000x that you'll get from being on the ground floor of the next big thing.

For example, Horace Rackham was an early investor in Ford and he received a 1300x RoI, Peter Thiel received a 3000x RoI on his investment in Facebook, while Kleiner and Sequoia capital each turned $12.5 million into $2 billion through their investments in google.

If strategy A is buying lottery tickets at $5 and strategy B is buying the lottery tickets at $10, A is twice as good off. It doesn't matter that the earnings are dominated by one single winning lottery ticket; strategy A is always twice as good as strategy B. So getting terms that are twice as good for a VC will double their expected earnings.

Sure, if you just consider the winning ticket, it doesn't matter whether you are paying $5 or $10 for it. The thing is that you don't know whats the winning ticket, and it does matter whether you are paying $5 or $10 for each.

You're still not getting it. It doesn't matter how much of the lottery winnings you get, the only thing that matters is winning the lottery or not.

20% of DuckDuckGo is a rounding error compared to 10%, 5%, or even 1% of google.

I'm not getting it because the reasoning is not sound. Your reasoning is basically "the numbers are BIG! so a factor of 2x doesn't matter". If you can get your lottery tickets for half price, you can buy twice as many lottery tickets, and double your chances. Equivalently, getting 1% of Google or 5% of Google is a 5x difference, which is huge. That could easily mean the difference between a net profit or net loss for an investor over all his investments.

If you really believe that the terms don't matter, then I'm sure lots of YC startups are happy to take money from you at terms that are 5x better than what YC offers.

Lottery tickets are a good example in this case. By definition, strategy A and B cannot both be winners (there is only one winning ticket). So the only thing that will set either apart is if one of the two strategies has the winning ticket. The price per ticket is only relevant if neither has the winner, in which case you're comparing who had bigger losses.

The reason I like the lottery example is that two venture capital firms don't have matching portfolios (if they did, then valuation would matter for relative performance). In reality, when you compare firm A vs firm B it's the performance of the startups that determines the winner (not the amount of equity owned).

Yes, in the end the VC with the winner is going to win, but that's beside the point even if there is a single winner in the world (which in reality is obviously not true, there are not dozens but hundreds of huge ROI winners). The point is that you don't know the winner beforehand. A VC who is getting 2*x% equity for $y is expected to perform twice as good as one that is getting x% for $y. The arguments that are being made here are incredibly vague. I'd love to see an argument based on solid logic why valuation doesn't matter much. I'm sure PG is right, but I'd like to understand why.

The point of this whole debate is this: VC return = equity * performance. Optimizing for the former is much less leveraged than the latter, since performance can vary by 10000x. If asking for better terms means you lose out on any deals then doing so is probably not in the firm's best interest.

Trying to maximize your share of individual deals causes you to lose the best deals. This is because a) the best deals are often expensive, and b) maximizing your share empirically causes people to consider you a dick, and people with reputations for being dicks don't get chosen by the best startups.

It's not the same equity. Quality is not distributed equally among the sample set of companies. The great startups (as judged retroactively via returns -- e.g. Facebook and Google) often (but not always) can get multiple competitive offers from top-tier venture firms, so having some abstract theory about how you're going to only pay low prices significantly damages your opportunity to invest in the companies that are going to generate all the returns.

As it turns out, the numbers are BIG! so a factor of 2x doesn't matter. This is literally how it works. The only thing that matters in venture capital is being in the small number of companies (15 out of about 4,000 per year) that generate 97%+ of the returns. Those can pay off 1,000 to 1. Fiddling around on terms or bargain shopping or refusing to pay up for quality all reduce your odds of being in the winners, which kills your chances of winning as a VC.

Getting terms that are twice as good only works if no one rejects your offer.

Suppose we select the top 100 start-ups according to whatever criteria we use.

We can now proceed in one of two ways. a) Make the minimum offer that we know all of the start-ups will accept.We now have a portfolio of 100 investments.

b) Make a lower offer that only some of he start-ups will accept. We now have a portfolio of say 90 investments.

The question is which portfolio will portfolio will perform better. If there is no difference in average quality of start-up between the portfolios in a) or b), then portfolio b) will do better (because we have obtained better terms).

There is no guarantee that this will happen. It could be that he or she has lost the only 10 companies that will be successful.

This is the problem that the VC has to face.

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