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How Do Venture Capitalists Make Decisions?

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Re: How Do Venture Capitalists Make Decisions?

#41

Post by mathattack »

This is very interesting research. I'm interested in anything that goes beyond Survey data to what actually happened. (VCs may say founding teams matter most, but I also say that I eat less than 2000 calories a day - memory is suspect) I'm also interested in how this would look weighted on firm size or returns. There are lots of small VCs out there who don't make money. How do the VCs who funded Google/Facebook/Apple/Oracle invest?

There's a ton of academic research on public equity investment decision theory. It's great to see private market investment get some focus.

Re: How Do Venture Capitalists Make Decisions?

#43

Post by lappa »

Retric wrote: post #15
gohrt wrote: post #8

Earlier quoted context omitted.

median is wrong metric for an asymmetric distribution.

That's reasonable at a fund level, but when 50% of the firms have negative returns why do people use them?

If you have 5 firms with ROIs of -10%, -5%, -3%, 1%, 14% and 31%, then 50% of the firms have negative growth rates and the median firm loses money.

However you can observe that if you invested $100 ($600 total) into each firm, you would end up with $636.

Median return isn't a very useful measure of the health of a sector. It is a predictor for risk, but not a very good one.

Re: How Do Venture Capitalists Make Decisions?

#44

Post by Retric »

lappa wrote: post #43
Retric wrote: post #15

Earlier quoted context omitted.

That's reasonable at a fund level, but when 50% of the firms have negative returns why do people use them?

If you have 5 firms with ROIs of -10%, -5%, -3%, 1%, 14% and 31%, then 50% of the firms have negative growth rates and the median firm loses money. However you can observe that if you invested $100 ($600 total) into each firm, you would end up with $636. Median return isn't a very useful measure of the health of a sector. It is a predictor for risk, but not a very good one.

Except the worst returns are closer to -100%, the median is closer to -30% and only a small fraction are positive.

Also, your example was 7 firms with the median being 1% and a positive return.

Re: How Do Venture Capitalists Make Decisions?

#45

Post by qwrusz »

lpolovets wrote: post #34
qwrusz wrote: post #23

Earlier quoted context omitted.

b) You can't generalize having magical abilities to pick top quartile managers ex ante. a) Some bigger LPs diversify across multiple VC firms and smaller LPs may access fund of funds (though very expensive). Either way broad diversification across VC funds is not significant in the industry. One reason is because VC fund returns and broad exposure to multiple VCs is not really the main point here - it is the startups…

b) Probably true, but in VC some of the top managers seem to be fairly consistent. I think that's one reason that LPs invest in emerging funds: if they hit the next Benchmark or Lowercase, that fund will soon be closed to new investors, so the only way to have an allocation is to be an early backer. a) I generally agree. I was just trying to illustrate why mean and median aren't great for analyzing asymmetric distrib…

Well ya, if some VCs aren't open to new investors then LPs must invest with emerging managers. The extent to which top managers will revert to the mean is anyone's guess and years away from an answer.

Why not just call it like it is...VC is really just a people business, there's money involved, but trying to quantify the process at all can be misleading. A VC firm is a small group of people (partners) using their best judgement and experience to find another group of people (founders) worth investing in. That's it, there's a ton of key man risk and there's no secret sauce.

Lowercase and Matt Mazzeo are a great example: VCs are basically just like Hollywood talent agents who get to find the next movie stars and help them along a bit - but in VC they are finding the next big tech founders instead of actors. These are people businesses, numbers can't really capture it but they can distract.

I didn't mean to get into a statistics debate on here. The great thing about VC and startups is everyone gets to be right until they're not :)

Sidenote: I hear you guys are running one the best shops in the space. Congrats on the recent close. Best of luck to you and your portfolio co's.

Re: How Do Venture Capitalists Make Decisions?

#46

Post by lappa »

Retric wrote: post #44
lappa wrote: post #43

Earlier quoted context omitted.

If you have 5 firms with ROIs of -10%, -5%, -3%, 1%, 14% and 31%, then 50% of the firms have negative growth rates and the median firm loses money. However you can observe that if you invested $100 ($600 total) into each firm, you would end up with $636. Median return isn't a very useful measure of the health of a sector. It is a predictor for risk, but not a very good one.

Except the worst returns are closer to -100%, the median is closer to -30% and only a small fraction are positive. Also, your example was 7 firms with the median being 1% and a positive return.

The explanation completely went over your head. The numbers weren't from measurements of actual firm performance, they were demonstrative examples to explain why measuring the median isn't very useful in this case.

And no, my example was 6 firms with the median having -1% growth rate, for the record.

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