[logicallee]

Actually you're an extremely sensible investment. :)

If you could close it in an hour how much money would you raise on standard terms and at what valuation? (You can list both as a multiple of any metric you pick - any metric, including unjustified projections if you want - if you don't want to name figures here.) Obviously given what I just shared I'm not a VC.

[tptacek]

No, we're a nonsensical investment: there is no story we can tell about how our equity becomes liquid in 10 years, and our growth, while very pleasant for us principals, is unlikely to lead us to a place where our eventual liquidity would pay for the failures of the other 9 companies in a portfolio that included us.

It's not a moral debate. The portfolio math has to work, and things have to work on a timescale that works for fund LPs. At the end of the day, venture capitalists are simply an adapter cable that plugs small chunks of LP endowments and funds into baskets of companies with an N% chance of exiting >7x within Y years. If your company can't do that, the adapter cable doesn't fit your company.

[nikanj]

You seem to be mostly right. In the past, VCs funded crazy moonshots and local banks funded sensible old-school companies with 10% per year growth and 15% profit/revenue ratios.

Small community banks don't really exist anymore, and large banks don't really seem to be funding anything under $10 million nowadays, except mortgages.

[C7H8N4O2]

> We're a nonsensical investment

for a standard VC, sure. Maybe there's a venture investment philosophy for non-unicorns. [0]

[0] https://sparktoro.com/blog/raised-a-very-unusual-round-of-fu...

[tptacek]

This doesn't really offer that; it documents a seed round raised by angels by a company that doesn't want to engage institutional VC because they demand a 10x success.

VCs aren't demanding 10x successes because they're lazy; they do it because the winners have to pay for the losers. This isn't even a VC-specific pattern; you see it in almost every hits-driven business.

[logicallee]

Respectfully, I think this is a rather muddy estimation of probabilities and returns, as I can illustrate like this:

Suppose I had $100 million to spend on literal lottery tickets and my goal was to average a 10% per year return on it across all of my "investments". Mainly I try to find places that haven't paid out a large jackpot yet receive low media coverage, so that I have a positive expected return: then I buy a whole lot of lottery tickets there without alerting my competitors to the fact that the lottery tickets have a positive expected value due to the accumulated jackpot, that people seem unaware of.

Now: if my bank where I'm keeping the $100 million, which is stable and conservative, gives me an offer to purchase a 1-year bond from them that pays 12% should I take it? Will it help me achieve my goal of netting 10% returns?

You may think, "No - because that 12% is not going to pay for the non-winning lottery tickets."

But this is muddy thinking because the 12% is not in the same basket of risks as the lottery ticket purchases. It is simply incorrect thinking to group them together.

So yes, tying some of the money up for a year in a bond that pays 12% will help me make my goal of earning a 10% return, even if my strategy is to earn 10% by buying jackpots.

Of course I can be stupid and blow the $100 million on nationally announced huge jackpots where everyone else knows about it and all my competitors are also buying tickets, so that the expected value of the tickets is actually less than I pay for them. That's before the loss that I take on all the logistics, my office, etc. This is kind of what VC's do. They lose money.

You can characterize it descriptively, but please don't call it a sensible strategy.

---

I'm still curious about your answer to how much money you would raise (perhaps expressed as a multiple of something) and at what valuation (again as a multiple of something, even projections if you want), if you could close it in an hour no questions asked. Just to throw this out there, I wouldn't raise $100 million at a $1 billion valuation for example, since I don't have any good use for $100 million. How much would you raise if you could, and at what valuation?

Forget the VC's, they're not in this conversation. We've already established they're in it to live on someone else's dime and lose money ;)

[jasode]

>Suppose I had $100 million to spend on literal lottery tickets[...] Now: if my bank where I'm keeping the $100 million, which is stable and conservative, gives me an offer to purchase a 1-year bond from them that pays 12%

In your hypothetical... if "lottery tickets" are the metaphorical stand in for "unproven startups", what does the bond paying 12% realistically stand for?

There isn't a AAA-rated bond that pays 12%. Or, to generalize further, there isn't an investment vehicle <X> that guarantees to pay VC_hoped_for_returns plus +2%. (In any case, if we're talking about AAA bonds, the LPs can just invest in that themselves without involving VCs as middlemen. E.g. you don't need VCs to buy US Treasuries on your behalf.)

To get higher interest rates that compete with good VC returns, you're getting into junk bond territory. Junk bonds have higher risk for defaults. Junk bonds require more research to assess returns. One could also try to sell the bonds on the bond market before the maturity but either way, you're now back in "lottery ticket" territory for bonds.

You're creating fictitious scenarios that don't have realistic choices.

[logicallee]

I just meant to show the probabilities. (Such a bond wouldn't have to pay for non-winning tickets.)

Whole scenario is totally unrealistic. (Though if I parked $100M in cash at a bank I would not be surprised if it offered me a AAA bond @ 12% for, say, $500K. This will cost them $60K per year or 0.06% of this totally unrealistic principal. Maybe they'd do this to mollify me, I don't know. Point is, if my target is 10% returns then I should accept!)

What the bonds stand for is tptacek's business, which " has a Y2 ARR(!) and revenue target that I think would make a lot of YC companies pretty happy" but is "not a sensible investment for venture capitalists".

[tptacek]

You're saying we could do a debt financing to expand the business. Yes, we could do that. We wouldn't, because debt sucks, but I agree it's an option that is available to us, where venture funding is (I think, and am fine with) not.

[logicallee]

>where venture funding is (I think, and am fine with) not

well yeah, if someone doesn't want venture funding no VC is going to beat down their door and make them re-do their business plan so they can take an equity investment :)

what I said applies more to companies that do want or need venture capital for their plans. These startups are not getting enough first financing checks.

[tptacek]

In addition to the point 'jasode makes, I think there's an additional unrealistic subtext to the argument you're making, which is the idea that companies with stable but unspectacular growth are somehow less risky than shoot-the-moon startups.

But this just isn't true. In addition to the fact that companies fail a lot more often than operators recognize, there's the fact that a company winding down after years of solid but unspectacular returns is also a failed investment. Companies don't have to lose product/market fit to "go out of business". All they have to do is fail to compete with the operators other options. Eventually, somebody else will outbid the company for key talent.

Slow-burn companies can keep going for decades before this happens. It's not bad to be a slow-burn company! I've spent most of my career in them! But to take money from LPs, you have to have a story about how you can pay them a return.

[logicallee]

Yep: for companies at their first financing stage, "companies with stable but unspectacular growth are somehow less risky than shoot-the-moon startups".

When small community banks disappeared (as nikanj points out), who would have financed these "sensible old-school companies with 10% per year growth and 15% profit/revenue ratios", that didn't make them riskier.

Meanwhile your subtext is that you just don't want to raise money. You spent a lot of words pinning it on how it's bad for VC's but all I asked you is what term sheet you'd write for yourself if you closed an hour later. None: you don't want investment. That's fine!

[tptacek]

Companies with 10% growth Y/O/Y fail all the time. A portfolio of 10 of those companies will consist primarily of failures. Most of the companies in that portfolio will cease to exist without returning money back to investors. By your own definition, none of them will grow explosively, and so the winners can't pay back the losers. Pick a success rate and an investment multiple for the winners and do the math.

Banks do fund businesses like this, all the time. The difference is that they fund with debt instruments, not equity. You're obligated to pay them back and can't deliberately manage your business to avoid the obligation (chances are, you'll have to co-sign the obligation personally).

If all you're arguing for is broader availability of lines of credit, by all means, keep asking for that. But that's never been what startup investors provided.

[logicallee]

I defined what I was arguing for: more checks written to startups that are already printing money and raising their first round.

In 2018 more than 1,800 startups are fantastic equity investments at a time when they're printing money, and VC's are idiots for writing 1,800 first funding round checks to startups total, nationwide. I couldn't believe how low that number is. You said, "well yeah they're printing money but it's the wrong kind of money". You would have called Airbnb the wrong kind of startup and you would have stood there and told me VC's are totally right not to invest in them. 9 years later here we are, $31B+ valuation.

It couldn't raise its seed round and it's obviously because VC's are idiots who are paid to lose money. It sold cereal on national TV instead. That's a fact.

[stealthmodeclan]

The crux of your arguement is that the same returns can be derived using different set of probabilities and different kind of companies which probably won't achieve hyper growth but still are profitable and nice bet.

VC constraints:

1. VC has to get out within a specific timeframe, let's say 10 years and return all money to the LPs.

So VC can't afford to wait indenfinately collecting narrow streams of money.

That leaves you with very limited opportunities.

2. The number of companies they can deal with is small. There is a cost per transaction (funding), fewer transactions you make, better you do. But some transactions are must for VC math to work.

Banks also used to make only big loans in past. Micro lending is a recent thing. Algorithmic underwriting which doesn't even require manually looking at the balance sheet is based on heavy data collection, KPIs made feasable by technology advancement like big data processing etc..

3. VC can't fund anything which doesn't match their investment thesis. The LPs often start fund with a specific mission, for example, "advancement of AI for humanity". The VC partners often are veterans in specific industry and their resources are often useless in other industries.

This further reduces the number of companies they can fund.

4. You seem to assume all VC are chasing returns, well no! If our mission is "AI advancement". It's much better, if we've 2-3 focused winner companies in this niche. Fewer companies achieve better leverage, industry penetration, economies of scale and ofcourse, too big to fail.

5. Most of those small profitable companies are not able to keep stable revenue for 3years+.

One of the most misunderstood thing about VC, is that VC money wants maximum returns.

No! VC is a quest for control over new monopolies with enough holding, VC can influence and install their own management.

Money is cheap for them.

Imagine if you are an engineer and you own the largest semiconductor company. It's established fact that the old monopolies die and new disrupters emerge as new monopolies. You can't change this!

What you can do is control new disrupters by purchasing equity in them.

You do this by starting a VC fund and putting money derived from your semiconductor business in the fund. You can liquidate some of your holding it's not too hard.

Your VC funds thesis then becomes, "semiconductor advancement".

Then GPs will not chase the startups which have nothing to do with the semiconductor as their main focus.

If you don't do this, you watch your semiconductor empire dying. If don't even have stakes in new semiconductor disrupter monopoly, how do you maintain your dominance in this industry? That has a price, so absolute returns do not matter.

When a VC funded company dies, LPs do not cry. They cheer because another potential disrupter died trying, this can explain why some VCs are downright bad as they want you to fail.

Secondly, some VC funds have LPs who get their money from industry underdogs and really are after a disrupter who can unseat the current #1. So, they might be more helpful.

VCs are after potential disrupters.

Now if they want to kill the potential disrupter or help it grow that depends on the people who's money is at stake. No one is really going to share their motives upfront.

[logicallee]

This was hugely interesting, I read it twice carefully. (Yes, you correctly interpret my argument but I was fascinated by the direction you went off in.)

I can see you're a new-ish member (created 7 days ago and shown in green), and have stealth in your name, but I reviewed your comments and they're really high-quality. I'd appreciate if you would get in touch with me at my email listed in my profile for some out-of-band followup questions. Thanks for sharing your perspective on HN and welcome again. Very good posts.