"A Unified Theory of VC Suckage"
Brad Feld pointed to an essay by Paul Graham, entitled “A Unified Theory of VC Suckage.” (VC is short for venture capitalist, the folks who invest in certain types of startup companies.)
I used to take it for granted that VCs were like this. Complaining that VCs were jerks used to seem as naive to me as complaining that users didn’t read the reference manual. Of course VCs were jerks. How could it be otherwise?
But I realize now that they’re not intrinsically jerks. VCs are like car salesmen or petty bureaucrats: the nature of their work turns them into jerks.
What I really like about Paul’s essay is that it talks about some of the economic pressures on VC funds, and how those pressures get pushed to startups.
This is a strange thing for a startup guy to say, but I have a lot of sympathy for venture capitalists. In some ways, a VC fund is like a startup. You have some guys who know something about business. They go out looking for money. If they get the money, they have 10 years to make good on it. I’m might get pilloried for this next sentence, by people who skim through why I’m saying it: Unlike a startup, most VC have relatively little in the way of compelling advantages. That’s not to say that investors are indistinguishable, only that it’s even harder for a VC firm to create, maintain, and communicate a compelling advantage over the other firms.
Most investors don’t get to build disruptive technology. They get slight first mover advantages. Most VC are in cutthroat competition with other VC for the ability to put cash into a few good companies, and a lot of ‘maybes.’ A good investor brings good strategic advice, and a big rolodex, and a willingness to work for you. Well, so does that other fund. Compare to a startup which can get a strong first mover advantage, building, say, a database that’s 10 times faster, or with six signed customers in the fortune 500.
So I think, to extend Paul’s economic analysis of why investors and startups clash, it goes back to the limited partners who invest in venture capital funds, and the way they need to behave.
As a side comment, Rick Segal asks:
And what is this issue with a liquidity event. Why is that evil? What’s wrong with making some coin, selling companies, IPOs, mergers, whatever. I’ve yet to see anybody, Paul included, to give me a compelling reason why this aspect of venture capital means we all suck.
Let me start by reiterate that I don’t buy the suckage claim. At the same time, there are businesses which may look like VC-fundable businesses, and, to everyone’s surprise, turn out to be organic growth sorts of businesses. For these companies, who need to contort to give their investors an exit, the liquidity requirement can suck. If the investors and CFO are good, I think there are usually options, such as a management-lead leveraged buyout, converting equity to debt, and giving the cash to the investors. But, really, the issue is that VC firms are on a ten year schedule, and that creates pressure on the startups to be on (at most) a 5-6 year schedule. If you don’t know this going in — if you’re starting a startup to build a great business like your grandparents did — then you can find a world of hurt.
Nice post, Adam, very well thought out. Here are some personal observations.
First, VCs have very very hard time being different, you are correct. In the end, super smart people who lose other people’s money, well, we know how that movie ends. So, you are right in the sense that we don’t, as an industry, have issues that start ups do in that sense. It’s about the numbers, to a very large extent.
I’ve seen a number of start-ups where, ooops, not a VC investment, uh oh, what now. The liquidity requirement does in fact suck because everybody screwed up.
Part of the really ugly term sheets have language in them that can, in the extreme, take somebody’s company away from them and force a sale in order to get the investors out. Again, that stuff sucks and I sure wouldn’t want to be on the receiving end of that gig; 10 for 10 on the sucks meter.
Which brings me to the general point I was making about Paul and his fifty foot wide they all suck paint brush.
A good/smart/professional VC should have this EXACT conversation with the person building the business. Then, wait ten days, and have it again. And again. There is no VC I’ve ever met that doesn’t ramble on about wanting multiple exits, liquidity events, time horizons, etc.
This means that even if the start up person missed all of it, you still need to have the do you understand chat before the check goes into the bank.
Paul is going to go try to get some start ups off the ground. It will be interesting to see how that works out. It’s a good idea and he is putting his money where his mouth is so let’s root for him and cheer on the start ups.
Good, post Adam. Hopefully, we all will suck less.
Best regards,
Rick
VCs Suck, but you can still store your data on FreeBSD
Adam points to an essay by Paul Graham on A Unified Theory of VC Suckage. Sure, I guess, and if you like learning how and why, read on. Meanwhile, I’ll just leave you with this amusing footnote: [2] Since most…