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VCs are scared when they should be greedy

blog.aaronkharris.com

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Re: VCs are scared when they should be greedy

#211

Post by lotsofpulp »

gumby wrote: post #114
lurkervizzle wrote: post #101

Earlier quoted context omitted.

Specific anecdote - SaaS companies selling to other SaaS companies is going to cause a mini-winter in that sector. My company (which we thankfully sold last year :praise) had several (though not exclusively) high-growth tech companies as customers. Now, when I look at layoff announcements, I see a lot of our former customers. Additionally, with budget freezes (driven by VC RIP decks), these same companies aren't buyi…

> And many tools now are priced based on headcount. Ah, live by the ARPU, die by the ARPU: you lack of control over the "U" means your company performance is coupled to the broad market! Thanks for this example. It's obvious in retrospect but apparently not prospectively.

Assuming you have the pricing power to not be affected by the broad market, you would simply increase pricing to maintain ARPU.

If you cannot increase pricing, then your performance is coupled to the broad market regardless of how it is measured.

Re: VCs are scared when they should be greedy

#212

Post by frognumber »

lpolovets wrote: post #22

(Context: I'm a VC) Some great points in the post, but I also see a few additional dynamics at play: 1) The last 10 years have been great for VCs and startups, but now VCs are thinking about how to make their funds last longer. Two reasons for this: first, time diversification matters. If you think markets might go down even more, you don't want to deploy the rest of your fund quickly, you want to spread it out over…

(Context: I'm a successful serial entrepreneur, but never on the fundraising side)

My experience is that the best investment opportunities are counter-cyclical. During a down economy, talent is cheap. Competition is low. It's easy to build a growth business which explodes when the economy enters a growth stage. It's also cheaper, more focused, and more efficient to have 5 people work for 5 years than 100 people for 1 year. 5-20 people is sort of optimal.

That requires (more) patient capital, and longer times to IPOs, but has higher ROI.

I think I could build any of several successful businesses with a smaller investment -- on the order of $5-10M -- sustained over a longer period (optimally, around $1-2M/year over 5 years). I don't think I'd want or need series B or C funding. That can accelerate things, which is helpful if I'm competing aggressively against five companies, and it's first to grab the market, but it makes companies a lot less lean, focused, and aligned as well. It also dilutes equity a lot, for everyone. Stock options have a reputation for being worthless, and when you run the numbers, that's generally true for anyone beyond the founders.

Do you know if there are investors who can handle this type of structure? Or what constraints there are to having these kinds of investments? I understand the current time windows that a VC fund is open, but it's odd to me that there aren't more diverse types of funding available. Do you know why people haven't set up VC funds with other structures? It seems like a major inefficiency and friction....

Re: VCs are scared when they should be greedy

#213

Post by rypskar »

lotsofpulp wrote: post #208
quickthrower2 wrote: post #201

Earlier quoted context omitted.

My agents: All years: There’s never been a better time to sell! In other countries the agents only make commissions from the seller not the buyer, hence getting the listing is the big thing.

Assuming you are referring to the US, buy side real estate agents get paid by the sell side real estate agent (technically the real estate seller pays commission to the sell side real estate broker, which then pays the sell side real estate agent and the buy side real estate broker which then pay the buy side real estate agent).

Is buyer side real estate agent normal in other countries and what do they do except making it even more expensive to buy a house? It is still the buyer who pays even if it is the seller who pay the commission since the commissions are baked into the sell price

Re: VCs are scared when they should be greedy

#214

Post by sooheon »

drdrek wrote: post #206
simonbarker87 wrote: post #200

Earlier quoted context omitted.

I’ve often heard the modern VC route described as a Ponzi scheme with the public market being the greatest of the fools, I don’t totally buy into the idea but your 3rd point really does highlight how close it all is to a Ponzi scheme. So much value is absorbed in the VC pipe than by the time a company IPOs the chance of retail investors seeing returns is minimal to none.

Think about it in this way: You want to open a wholesale food distribution business for restaurants in a Manhattan You want to make sure that enough restaurants will buy from you They want to make sure that enough costumers will buy from them The customers are going out less because of a downturn in the economy So you do not open our business because the stock market is down Is any business a ponzi scheme? P.S Saying…

If early capital thought they would get better risk adjusted returns holding on to companies, they wouldn't exit.

When considering a trade, you have to ask yourself "what do I know about the future prospects of this asset that the other party doesn't?" For IPOs you can see how stacked this transaction is against the public.

Re: VCs are scared when they should be greedy

#215

Post by jacquesm »

seibelj wrote: post #179
jacquesm wrote: post #175

Earlier quoted context omitted.

LPs in a fund usually - possibly not always - have the same conditions except for the 'anchor' LPs, who are declared up front to the other LPs and who put in a substantially larger chunk of cash and commit before the fund is even officially opened. They are committed to do so and are listed in the rest of the documentation by name. Even the anchor LP agreements that I've seen do not allow those to default on their co…

You are confused because you think the contracts mean anything in such a world. The contracts are worth less than the paper they are printed on when push comes to shove and you are facing a whale.

We're talking about whales facing whales, think Elon Musk vs Twitter and believe me contracts mean everything in that world.

There isn't an alternate reality where contracts are meaningless.

Re: VCs are scared when they should be greedy

#216

Post by jacquesm »

seibelj wrote: post #177
jacquesm wrote: post #43

Earlier quoted context omitted.

As an LP in a large fund: that's definitely not how it is. As an LP you pre-commit to a certain level, and when the capital call comes you perform or you will be found to be in default when a whole pile of clauses kicks in that you really do not want to have to deal with. You will have to have an extremely good reason (such as being already bankrupt) to be able to avoid a capital call that you have committed to.

You are viewing the problem wrong. If you don't want to pay and you are a big fish, you just tell them not to ask. VC world is based on reputation and politeness. Causing a big stink is not a good look for anyone. If you are a big LP and you say, look buddy, we are taking this quarter off, what do you think is going to happen?

What would happen is a revolt of the other 200+ LPs who all collectively represent a much larger fraction of the fund than any one whale because they will have to cover for the shortfall; not to mention other whales who may see things differently.

On every capital call there is a statement that lists the total amount and the pro-rata and if the ratio there would suddenly change that would be a breach of contract. As an LP you know up front how big a chunk of the total fund your commitment will be with possible upside if the fund is oversubscribed and if it is undersubscribed it either won't launch of you will be made aware of the change and given the option to walk away.

To see the fund effectively shrink post launch and the shortfall pushed onto the smaller LPs is ridiculous, especially if LPs were not previously told that this could be the case.

Re: VCs are scared when they should be greedy

#217

Post by HighlandSpring »

xthrowawayxx wrote: post #23
fdgsdfogijq wrote: post #15

Rather than complain about how VCs arent good investors, people should rail on the system that selects VCs. Which is mostly admittance to prestigious MBA programs/colleges. So please write a post about how those schools arent selecting for good investors, because these diatribes about a "flawed" industry are very surface level compared to the underpinning power structures in america

How do we distinguish between: "VCs are are selected because they go to school X", "school X is good at creating VCs", and "school X receives more potential VCs"? My guess is probably more statements 2 and 3 for the usual suspects eg Stanford

It could be mostly 1)

If you hire a smart kid with an MBA from stanford and he gives you a bad name with a series of mistakes, well, bad apples happen. If you hire a smart kid from a no name university and the same happens people will be quicker to blame you.

Credentialism is a thing for the same reason brand recognition is a thing. When a product with good reputation fails it's bad luck. When a product with bad reputation fails it's to be expected. Power perpetuates.

Re: VCs are scared when they should be greedy

#218

Post by fauigerzigerk »

acd wrote: post #89

"In contrast with the scenario in 2000, most of today’s tech companies are real businesses." I disagree that many startups have viable ideas that will generate black numbers and organic growth. Bold founders have sold startup ideas which are not sustainable. Ie investment capital have prefered bold founders that could give vision of high future returns wework for example. A small number of startups will become awesom…

>Higher interest rates will adjust future return calculations that is brilliant from the article!

I think discounted future cashflow is unfit for purpose as a valuation metric in an inflationary environment. It is based on the assumption that interest rates and future cash flows are independent variables. They are not.

There's no dispute that the present value of a given amount of future cashflow is lower when interest rates are higher. This part is correct. It's simple arithmetic.

However, when interest rates rise because inflation rises, it means that future cash flows rise as well, because future cash flows are linked to future revenues, and future revenues, by definition, grow with inflation.

Re: VCs are scared when they should be greedy

#219

Post by SilverBirch »

sooheon wrote: post #214
drdrek wrote: post #206

Earlier quoted context omitted.

Think about it in this way: You want to open a wholesale food distribution business for restaurants in a Manhattan You want to make sure that enough restaurants will buy from you They want to make sure that enough costumers will buy from them The customers are going out less because of a downturn in the economy So you do not open our business because the stock market is down Is any business a ponzi scheme? P.S Saying…

If early capital thought they would get better risk adjusted returns holding on to companies, they wouldn't exit. When considering a trade, you have to ask yourself "what do I know about the future prospects of this asset that the other party doesn't?" For IPOs you can see how stacked this transaction is against the public.

I don't think this is right. The reason VCs exit is simple, they're VCs. They exist to invest in start ups. Their job is to invest in high growth, high risk start ups, and the risk premium reflects that, they're a certain type of asset class. That's why people give them money. People don't give money to VCs to buy Walmart stock. If a VC thinks it can get a better risk adjusted return investing in Walmart then they're not a VC. Why would a limited partner want the VC parking their cash in an established business? They already have allocated their capital amongst different investments including VCs to get the mix of investments they want. So the right thing to do is as the company matures and risk drops, they exit their investment. If the company still offers good risk free returns, well then the LPs can buy the stock, or their hedge fund investments will buy the stock. But the fundamental issue is if VCs stay in companies beyond a reasonable point then they're not doing their job.

Re: VCs are scared when they should be greedy

#220

Post by SilverBirch »

pedalpete wrote: post #153
lpolovets wrote: post #22

(Context: I'm a VC) Some great points in the post, but I also see a few additional dynamics at play: 1) The last 10 years have been great for VCs and startups, but now VCs are thinking about how to make their funds last longer. Two reasons for this: first, time diversification matters. If you think markets might go down even more, you don't want to deploy the rest of your fund quickly, you want to spread it out over…

I've been trying to understand the medium-term implications of your first point for the market. My understanding is that if a VC raised a $1B fund, and the fund lasts for 10 years, the investments really need to be made in the first 5 years. If VCs are sitting on the sidelines now, AND making smaller investments, what happens in year 2 or 3 when they have to deploy those funds? Do you think deal sizes will get outrag…

It's perfectly possible for funds to return the capital to investors and just say "Hey, we couldn't find anything to invest in at a good price, so we didn't", and that'll look better for them because their ROI will still be good.

This is also likely to happen because big investors generally have their investments split between lots of asset classes by some ratio, so let's say for the sake of argument that Harvard's endowment is 30% equities, 30% private equity, 10% fixed income, and a mix of other stuff. If the value of their equities in the stock market fall through the floor that means their ratio is suddenly off, so they're going to need to rotate out of private equity and into equities.

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