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You read my mind! I've heard parents complain that their toddlers are getting too fat on sugary snacks, complaining about how much sugar is being put in snacks these days. Never once recognizing that they, the parents, were picking out the snacks, not their toddler.

VCs have a similar issue, which is that there are more LPs and other investors who didn't live through 2000 and are more 'growth' rather than 'business' focused. They are giving their money to people showing 'growth' then that is the metric that folks start optimizing. If VCs will only fund companies which are headed toward 'cash flow positive' then that is the metric that gets optimized. You can see this dynamic in action at YC demo day as the YC tunes what it is they want to see in the companies, what ever that is, it shows up in a lot of slide ware :-).

So I think Fred is grumbling that there is a lot of "less smart" money out there and he has to either sit out while it flushes down the toilet or compete with it in the companies where he wants in. And that cuts into margins and it cuts into discipline because people who think the next round of funding is 'in the bag' have much less concern with how they spend this round. It doesn't help that even the "smart" money has no where to go that will provide significant returns [1]. So that doesn't help either. The good news is that these things reset themselves, the bad news is that it always seems to catch some folks completely by surprise.

[1] The period of low interest rates has gone on so long it has now started flushing out 20 year t-bills and other multi-decade "safe" investments. This is probably a much bigger story than the WSJ and others have yet picked up. There is a lot of dynastic wealth getting crimped.

Not just dynastic wealth: it's crushing retired seniors (and there's a lot more of them).

My parents didn't inherit much, but made a lot of money in e.g. the '80s, and at least back then put a lot of that into Treasuries. They're now around 80 years old; I don't know the specifics of their asset allocation, aside from my father having some stock market holdings, but in general they're getting very little in the way of return.

Have US Treasuries ever paid more than inflation? Isn't that relationship basically stable -- meaning, when we had higher interest rates, we had higher inflation as well.

Historically yes, if you take into account that they are tax free their net return has been positive. Between changes in definitions of the CPI and the QE{n} programs however they have gone negative over the last 5 years. I expect that story to "hit" right around the time when the presidential race gets going in earnest, so later next year.

You seem to be confused:

1. US Treasury bills and bonds are not exempt from Federal taxation.

2. In your original comment, you referred to "20 year t-bills." There is no such thing. The longest dated Treasury bill is 52 weeks; they are most frequently issued with maturities of a year or less. You are confusing Treasury bills and Treasury bonds, which are not the same thing.

3. T-bills are short-term investments purchased for the security they offer; nobody buys them to beat inflation. Historically, they have never provided a real return significantly above that of inflation[1].

4. That the yields of 10 year Treasury bonds are not keeping up with inflation is not a news story. It's been talked about widely for years[2].

[1] http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/...

[2] http://www.bloomberg.com/news/2012-12-14/treasury-yields-bel...

You are correct, took me a bit to look it up by my tax exempt bond holdings are municipals not treasury bonds (well except for some series EE but that hardly counts).

I understood you to mean that seniors don't pay taxes on it, which in my parents and in-laws case is true (since they don't go over income thresholds to pay income tax). For seniors that are most affected by this (the ones with lower incomes), they probably don't pay tax.

The CPI definitions change to reflect consumption habits. In any case, CPI definition changes don't affect your perceived inflation or effective return -- it's just trying to measure what you might be feeling.

CPI affects Social Security payouts, that's a different thing than investment returns (but obviously does affect the well-being of seniors). CPI probably does understate perceived inflation for seniors. There is an index specifically for seniors (CPI-E) that has more healthcare in the basket of goods, and it's higher.

Whole asset classes are no longer viable investments, that's a serious problem. Especially with inflation now > interest.

>Whole asset classes are no longer viable

For example? Spreads between asset returns might be compressed, but I have a hard time coming up with assets that are no longer viable.

Nobody is entitled to "set it and forget it" returns. Loanable funds operate on the principles of supply and demand like anything else. When money is abundant - as it becomes when the Fed is easing - the risk premium shrinks. You don't get rewarded for money under the mattress or lent to the government. Instead, investors are incentivized to grease the wheels of capitalism by risking that money. That's our system.

> and he has to either sit out while it flushes down the toilet or compete with it in the companies where he wants in.

One of the dynamics that happened in the wake of the 2000 crash: There was quite a bit of back and forth between the VCs and the limiteds when everyone went into turtle mode. The result was that many VCs ended up reducing the size of the funds, which is in effect a pay cut since they take an annual percentage of funds under management.

It's really hard to justify 2% fees when you're only sitting on the money because that's the best investment at the time.

> It doesn't help that even the "smart" money has no where to go that will provide significant returns [1].

This is an inaccurate understanding of what is taking place.

It's not that there are no asset classes capable of delivering "significant" returns today; heck, the S&P 500 has nearly doubled in the past four years. It's that to get returns, investors have been forced to pay significant premiums and take on greater risk.

That said, the money that is pouring into startups (through venture funds, super angel funds and individual angels) is not money that was previously being invested in Treasuries. The startup bubble is being fueled by the public equities bubble, which is a rising tide that has lifted a lot of boats.

> which is a rising tide that has lifted a lot of boats.

More of an inflating bubble that has lifted a lot of boats...

It's a cascade, isn't it? Money that used to go into Treasuries has shifted into money-market funds, money from those has shifted into equities and bonds, money from those has shifted into riskier equities and bonds and so on.

> VCs should be far far more critical about the companies that they invest in, that the path to break even is clear

Or should they? My impression is that many VCs are seeing bigger gains in shooting for $100mm+ acquisitions by Google/Facebook/Apple/Microsoft and cutting their losses on startups that don't make it, rather than trying to build sustainable businesses.

Hence, our very own pg's "Startup = Growth" essay: http://www.paulgraham.com/growth.html

Hence, the rumors that some VCs actively discourage startups from making any revenue at all (let alone profits), since those could act as anchors that drag down the acquisition valuation.

> Hence, the rumors that some VCs actively discourage startups from making any revenue at all (let alone profits), since those could act as anchors that drag down the acquisition valuation.

That's totally bonkers. But it's also 'rumors', do you have concrete examples?

No examples (it's hardly something they'd be talking about openly). This article spells it out pretty explicitly (with at least one named source) and is probably where I got the idea from:

http://bits.blogs.nytimes.com/2012/04/29/disruptions-with-no...

I was told this. The idea is you can make up any numbers regarding future revenues and it is hard to dispute when you haven't implemented any serious conversions, but as soon as you show what your true conversion rate is, it becomes possible to make projections.

Many years ago, I watched a TV interview with an Austin startup who said things like, "We can't tell anyone what we are actually doing, because some larger company will jump in and take over our market." That was the moment when I said, "We're done here."

I'm suddenly having that same feeling. If you had solid examples, I'd probably have more than just a feeling.

No one should ever invest in a company without knowing an accurate projection. People who do this are just playing the lottery.

Yes. But being on the other end of such a deal is like running the lottery.

It's not bonkers at all. A) investors/acquirers would rather see green fields and b) energy/resources diverted to revenue which would have been more valuably utilized for growth.

I was about to write a comment similar to yours, but after re-reading http://paulgraham.com/swan.html I'm less convinced. In particular:

There's no correlation between the percentage of startups that raise money and the metric that does matter financially, whether that batch of startups contains a big winner or not.

Except an inverse one. That's the scary thing: fundraising is not merely a useless metric, but positively misleading.

[...]

We can afford to take at least 10x as much risk as Demo Day investors. And since risk is usually proportionate to reward, if you can afford to take more risk you should. What would it mean to take 10x more risk than Demo Day investors? We'd have to be willing to fund 10x more startups than they would. Which means that even if we're generous to ourselves and assume that YC can on average triple a startup's expected value, we'd be taking the right amount of risk if only 30% of the startups were able to raise significant funding after Demo Day.

In this model, the VC's willingness to make risky investments becomes a kind of "thermometer" for whether an opportunity exists for an investor to win big. In fact, pg seems to be saying, "If VCs are investing in all of the startups, then that probably means there aren't any big winners seeking investment."

If that's true, and if VCs are investing in every startup, then it's likely that all of those VCs are going to lose. Whereas if VCs are only investing in 30% of the startups, then it's more likely that a selective investor can win big by investing in one of the 70% of risky companies that other investors aren't willing to go near.

> Hence, the rumors that some VCs actively discourage startups from making any revenue at all (let alone profits), since those could act as anchors that drag down the acquisition valuation.

That should come with a "don't try this at home, kids" warning. I've seen a case where an entrepreneur and his angel investors have a joint delusion about being able to pull that off even though those Tier Zero potential acquirers have no idea they even exist. He could have had a novel product in commerce two years ago but he would rather not have to answer for sales numbers meanwhile.

There are some cases where that's a rational plan. But not many.

>Hence, the rumors that some VCs actively discourage startups from making any revenue at all (let alone profits), since those could act as anchors that drag down the acquisition valuation.

I am not familiar with the funded startups/VC/acquisition ecosystem, so can you explain how a startup that is having revenue would drag down the acquisition valuation? Is it because it would drag down the acquisition price of the other startups that don't have revenue?

Usually chasing revenue means charging for things - removing free and instituting freemium in its place, for example. Generally speaking chasing revenue means pissing off some portion of your user base (i.e., the people who had no intention to ever pay you), and in doing so limiting your growth rate.

Valuation is deeply linked to growth rate and user base in this crazy industry of ours, so "we have X committed, paying users" is worth less than "we have 100X actives!!!!11one".

> Usually chasing revenue means charging for things - removing free and instituting freemium in its place, for example. Generally speaking chasing revenue means pissing off some portion of your user base (i.e., the people who had no intention to ever pay you), and in doing so limiting your growth rate.

Not sure I agree. You can give for free a limited version of your product and charge something for a better version, or you can use the freemium model.

Yes, and the company that doesn't have to care about revenue can just give the entire thing away for free and get users to sing their praises.

They will grow faster than you. This is why the "no-revenue" play works (well, until it stops working).

No, the idea is that revenue provides something to run numbers on to arrive at a validation. Call it an anchor or a sanity check: the idea is that it limits the acquisition validation. Whereas, it is argued in the article I probably got the idea from (http://bits.blogs.nytimes.com/2012/04/29/disruptions-with-no... ), having no revenue means the only limit is your ability to excite the acquirer with "growth potential" or "strategic value".

Here's an example to understand why revenue lowers your valuation. Twitter grows like crazy, adds millions and millions of users. Great, maybe it's worth billions.

But if Twitter had started charging for premium accounts, as an experiment, their revenue during the same period could have grown from $1M to $5M. Can a billion-dollar company have revenue of $5M? No. So the valuation of Twitter would have come back to earth, maybe $100M, maybe a bit more, but not "the sky is the limit" number.

So why don't investors discount a valuation because the fact that revenue is undefined, and not treat it like a near divide by zero?

It's important to remember that as brokers/agents of LPs' money, VCs price risk. The valuation of companies is distinct from that, and is normally the principal component of the pricing of the risk. However, if the market is in a mode of skyrocketing/bubbling, a larger component of the price is how much you can hype up the company before your exit, and basically trade on your own credibility/brand.

In a crude sense, it's a form of a confidence scheme...

Because revenue is easy but growth is very, very, very hard.

Seems to me the opposite is the case.

Any idiot can get signups when they have millions of VC money to burn. Getting people to actually pay you more than you're spending on user acquisition is infinitely harder.

Nope. It really isn't. The hardest thing by far is to get lots of usage. Once you have lots of usage, it's really easy to make money whether it's advertising, fees or whatever.

Can you name 2 or 3 "idiots" that have done what you suggest?

I don't think any of them are idiots. But here's a small sample of companies, off the top of my head, who have had serious problems in terms of monetization / revenue and needed to use investors / host company's money to run:

Pinterest. Groupon. Reddit. Snapchat. Instagram. Youtube (for many years). Twitter took a long time to make money. Most news sites have a hard time, which is why WSJ is paywalled (as mentioned in the article). On the "smaller valuation side", we could say FriendFeed, Zite, Hot Potato, Beluga, GroupMe, TweetDeck, Dodgeball.

It's much harder to than you may realize to monetize.

It's very hard to monetize, but it's orders of magnitude harder to get big in the first place.

Groupon and YouTube are printing money now that they are public. Pinterest, Snapchat & Instagram haven't even tried to make money (ie, they are doing what I explained). Most or all of those small ones never grew fast enough to matter.

Digg? Everpix? Myspace (though the original owners managed to cash out before it crashed)? Metafilter (not a VC-funded startup AFAIK, but having to shrink because they can't profit despite their popularity)? Twitter, though they haven't quite crashed yet?

It's a psychological thing.

If a company hasn't even tried to get revenue, then the sky's the limit. But as soon as it does it gets actual numbers, and those numbers are usually not as big as anyone's wildest dreams. Sometimes they're downright depressing, and they lead to that hard and unglamorous slog of optimizing business model and pricing strategy and such.

In big companies this often manifests in the form of the project cancelled right before (or right after) it goes to market. A project that's still pie-in-the-sky tends to excite the sales and business folks, but once it gets closer to go-to-market you start getting real numbers. A lot of times this leads to cold feet, the project loses favor, and sometimes gets cancelled right before it ships.

Reality is never as much fun as dreams.

The counter-argument though is that rapid growth in the beginning is necessary to have any chance of getting really big.

I've got an effort out there right now that's growing but has a revenue model in place. I know for a fact that if I take the revenue model away it will grow faster, and I've been having a huge debate with myself on this. The revenue isn't huge and the growth is slow-- do I trade that small amount of revenue for larger growth on the promise that I can get more revenue later? It's a tough question.

Exactly.

The classic, ostensible rationale for taking on large VC rounds is to accelerate growth. Not to cause growth in the first place. If a company's entire business model depends on spending massive wads of capital on things like loss leaders, advertising, unsustainable pricing, etc., then it's not really a business. It's a gimmick. It's a race to the exit.

These sorts of plays can and will cause negative externalities in the markets in which they operate. They "disrupt" those markets for a short while. The disruption comes not from changing the fundamentals of the market, so much as temporarily and violently turning pricing on its head by ignoring the profit equation altogether. That's unsustainable by definition. (And it's not to be confused with the legitimate practice of running at a loss, or breakeven, by plowing available profits back into growth).

To the extent that this is true, it's one of the major social criticisms of Silicon Valley-- that it's a Ponzi financial scheme where the game is to spawn massive but deeply unsustainable growth juggernauts and then sell them to greater fools like the public market.

One big problem which is hard to solve is the way bubble companies can easily drive the price down below something sustainable but it can take a long time to recover, if ever. We've seen that with a number of free services and also things like App Store pricing where all of the free / $.99 apps seem to have permanently lowered people's willingness to pay even a modest price.

For services at least you can market on the fact that your thing is sustainable. People dislike churn and will actually pay a premium for some credible business model beyond "don't worry about how we pay for it".

It's definitely a good marketing message but you have to hope that it'll resonate with a sufficient number of people to be viable. That's easier to do for a business service or something like personal backups than it is for many other product categories.

That's a very good point.

Most of your post reads like wishful thinking. Do you have any examples to support your contentions? My sense is the opposite: all the companies that got extremely large we're investing massively (Facebook, Salesforce, amazon being the poster children). Are there any companies that got big under your approach? Suspects include 37 signals and atlassian, I guess.

It's a lot harder to get big without burn. Offering value for free or very cheap is the easiest way to achieve exponential growth.

Why would they have to get big, let alone extremely large?

That's an assumption on your part. There are lots of companies in the $1 to $10M pear year in turnover and 20...40% net margins range that make their owners consistent fortunes. And by your standards they would qualify as 'tiny'. But that doesn't mean they are bad companies for their founders.

Simply put, we have different definitions of what a 'good business' is.

37signals and Atlassian are just as much outliers as dropbox and airbnb are.

In Silicon Valley these sorts of businesses are often derided as "lifestyle businesses." The Valley -- especially the big VC ecosystem -- wants big sector-conquering victories. That's because the VC industry is driven and financed by mega-hits.

Building a respectable, profitable business might be fine from a traditional MBA or bootstrapper's point of view but it's actually a failure in VC-land since it will not yield a monster exit.

What cankers about reading your comment isn't that it isn't true, so much as the implicit approval of the assumptions that (1) small businesses are small by choice rather than ambition, (2) all businesses have viable ways to raise money on equal terms, (3) funded competitors do NOT distort the market in a way that penalizes their unfunded competitors.

Jacquesm is rightly irritated at how funding unsustainable businesses distorts the revenue-getting potential of sustainable but unfunded ones (#3). Another example is the difficulty of bootstrapped companies ranking for any competitive search terms or getting decent press without venture capital and a PR engine. It is a LOT harder to organically grow into multiple distribution channels in a short period of time if you have to fund everything out of a limited slice of the market because you are competing against funded competitors who don't have those limitations.

Jacquesm's point is dead on. The entire point of raising capital is to buy competitive advantage. So if a VC doesn't think the money is being well-spent, they shouldn't have invested in that business or market in the first place. It is ironic to be in the position to buy competitive advantage, then get upset because people act like that is how you run a business.

I wasn't disagreeing, just pointing out the incentives and the underlying structural reasons that things are done this way.

Ah, thanks for explaining, and sorry if I took it the wrong way.

this old [2000] piece from joel spolsky on picking a growth model and sticking to it is still a good read:

http://www.joelonsoftware.com/articles/fog0000000056.html

It's a great read indeed. But I do disagree with the 'excel versus lotus 1-2-3' analogy. Microsoft engaged in plenty of unfair competition at that time and that's one of the reasons they succeeded.

So going into a market with entrenched competitors is dangerous except when you're backed my a monopolist that can afford to cross-subsidize.

> Think of your risk/reward profile. Do you want to take a shot at being a billionaire by the time you're 35, even if the chances of doing that make the lottery look like a good deal? Ben and Jerry's companies are not going to do that for you.

It took 14 years, but Markus Persson just proved him wrong on that one.

good point! it was very gratifying indeed to see minecraft explode purely via organic growth.

Mailchimp is another fantastic bootstrap success story. Hugely successful, but not talked about much because (1) they're not in the Valley (2) didn't raise boatloads of VC cash. Oh, and the founders still own almost the entire business (not as if that is important or anything)

As much as I hate those soundbitey things, I think "If growth is equal to health, then cancer would be good news" is one for the bootstrappers :)

Fantastic points, well reasoned post. As I've only done niche bootstrapped things, I'd never looked at it from that perspective before, where a bubble startup could screw up the sector for a long while, not just steal that day's lunch.

> There is something supremely funny about VCs complaining that their start-ups behave like funded start-ups and not like bootstrappers, who focus on revenues and profits right from day 1.

This struck me as well. The irony seemed lost...

You can't have it both ways. Bootstrappers who don't need your money, won't take it. People who do need your money, typically spend it, playing the longer game you've encouraged them to play.

> A healthy company would survive and grow even without VC investment, it's supposed to be an accelerator, not life support.

A thousand times this.

> "People who do need your money, typically spend it, playing the longer game you've encouraged them to play."

More than that, if you want the middle ground - externally financed but slower, more sustainable growth, you need to establish that from the get-go. Founders are chasing the fast 1000x exit because that's what VCs expect.

It's really interesting how, from different vantage points, we have the same complaint.

This industry, in the state that it's in, selects for those who over-promise, impress others with their charming but vacuous stories, fail to deliver, and make a mess that's really difficult for the rest of us to clean up. "What do you mean you can't deliver <SaaS X> for 25 cents per terabyte?" "What do you mean you can't do this story in one week?" "What do you mean we'll have to hire a maintenance consultant to get out of this mess?"

Institutions are still the main players and can develop persistent reputations and execute coherent strategies... but the game of private-sector technology itself is most successfully played by sociopathic individuals who make unrealistic promises, generate "flashiness" with minimal substance, and are promoted away from the chaos (say, into corporate upper management, or the VC investor ranks) before things start to blow up under their feet.

I had a long comment written that I think may give you some actionable hand-holds, the only remnant of that which I'm leaving here (because I don't think HN is the place to give personal advice, especially when it is un-sollicited) is that I don't think our complaints are the same at all. Feel free to drop me an email if you want to continue that conversation out-of-band.

This is esp. funny when the man writing the original article is an investor in Snapchat, which just raised $xxx millions at a $yy billions valuation.

+1000. You have hit the nail on the head.