In Silicon Valley Frenzy, VCs Create New Inside Track

http://www.wsj.com/articles/in-silicon-valley-frenzy-vcs-create-new-inside-track-1427992176

by larrys • 11 years ago

41 24 11 years ago

larrys• 11 years ago

If you hit the paywall google "In Silicon Valley Frenzy, VCs Create New Inside Track"

Excellent article. Should be read together with "MARKETS How Wall Street Middlemen Help Silicon Valley Employees Cash In Early." http://www.wsj.com/article_email/how-wall-street-middlemen-h...

michaelochurch• 11 years ago

At first, venture capital was (may have been?) like any other investment strategy: the goal is to generate a portfolio that delivers a high return on investment.

The problem? Variance, mixed with a short-term/instant-gratification culture at all levels of society. The more variance, the more whale-driven the business. You end up with binary returns: no whale, and you lose (relative to your peers) and even if you did everything else right it fucks up your career; or you get a whale, and you win. The doubles (3x) and triples (10x) don't matter and it's all about the elusive home runs (1000x). Or, I believe the term of art these days is "unicorn", because chasing an animal that only exists in the mind of people under 10 just makes sense in this culture of neoteny.

The second-stage venture capital wasn't about portfolio returns. Even if you had a profitable array of doubles and triples, you could face redemptions or struggle to raise the next fund, because you wouldn't have a visible proof of competence. Sure, you did 20% per-year, but that guy over there who lucked into Facebook did 25% per-year (even though that one lucky call saved him).

Also, the career-making allure of access outgrew the original job of delivering the best returns possible. So it became about "having been in on" a Google or a Facebook, even if most of the portfolio withered on the vine. That's why you get the culture of note-sharing (often inappropriate and illegal) and co-funding and collusion. VCs aren't chasing returns, which is what their investors want; they're chasing the intangibles that come with the appearance of prescience and social access, and those only come with the whales. An added bonus for VCs, which helps them personally but not their portfolios, of the extremely-high-variance strategy is that it opens up executive positions for underachieving friends who need favors. "Lifestyle" businesses that grow at 30% per year don't, because those tend to need specialized skills at executive levels. But the neat thing about a company that is really just a pile of cash and young coders ready to "pivot" on a dime is that any idiot can be placed at an executive level.

In this third phase, the game isn't about finding big winners but creating them. The VCs have fully grown into their role of king-makers, injecting huge sums of cash to end the game for all competitors almost instantly, create a "natural monopoly", and exploit it for 5-15 years until the monopolistic advantage fades (as it will if the idea is any good). Your product doesn't matter if your competitor gets a 9-figure injection, because that'll pay poaching fees for your best people, generate a lot of press, and push you aside.

That's where we are, now. The VCs don't invest money into a market that then decides what succeeds or fails. They have so much money that they pick the winners, with not only their resources but their nearly absolute power over exit arrangements. ("Call Tom at Google. He owes me a favor. Let him acqui-hire this stinker at $4M per engineer so I don't have to think about it anymore.") Obviously, there are constraints upon them because they can't just fund anything-- they would run out of political capital if all they produced were stinkers-- but they have so much power at this point that almost all valuations are recursive.

msandford• 11 years ago

I think I could distill your thesis down to "every investment strategy eventually becomes a Keynesian beauty contest" and it wouldn't lose a lot of punch, would it?

coffeemug• 11 years ago

the neat thing about a company that is really just a pile of cash and young coders ready to "pivot" on a dime is that any idiot can be placed at an executive level.

Can you give a few examples of companies in the last ten years that are "nothing but a pile of cash and young coders ready to pivot"? There are a couple of outliers where that did happen, but it is certainly not the rule.

Your product doesn't matter if your competitor gets a 9-figure injection

Can you give a few examples of a few companies with terrible products/early traction that got nine figure cash injections in the last ten years? Again, there might be one or two, but it is not the rule.

krampian• 11 years ago

> The VCs have fully grown into their role of king-makers, injecting huge sums of cash to end the game for all competitors almost instantly, create a "natural monopoly",

Yes, capital can certainly be a competitive advantage. Another manifestation of that is economies of scale. Most of the companies on the Fortune 500 have and exploit such economies on a daily basis, and I don't see them apologizing...

> "Call Tom at Google. He owes me a favor. Let him acqui-hire this stinker at $4M per engineer so I don't have to think about it anymore."

Do you actually have evidence that this kind of thing is going on? Could you post it if so? I'm thinking that Larry Page and plenty of other Google shareholders might be interested...

jgalt2123• 11 years ago

When Green Dot acqui-hired Loopt, Mike Moritz was on both boards.

gargarplex• 11 years ago

Mr. O'Church has neglected, or failed, to include ideas in praise of nepotism. In other words, expect that Google net benefits from access to Tom's network or experienced a favor from the VC previously.

There's even an idea for this in accounting: goodwill.

http://en.wikipedia.org/wiki/Goodwill_%28accounting%29

angersock• 11 years ago

So, what does this look like for the rest of us? Is it a viable way to raise money, like for an enterprise company?

aliston2• 11 years ago

I don't see how one can write an article about these funding rounds and not mention ratchets/liquidation preferences and executive/founder/insider stock sales.

I also don't see how one can look at these private, illiquid, balance-sheet gimmicks and think that the "valuations" are tied to anything in reality. It's a huge game of pass the bag, and it wont be pretty when these deals unwind.

jacquesm6• 11 years ago

All stock sales are 'insider stock sales' if they do not refer to a public company.

How else do you think people become aware of the opportunity to buy or sell a stock in a private company if not through an insider?

aliston2• 11 years ago

I am referring to the practice of taking money off the table vs. issuing new stock.

revelation• 11 years ago

What's the problem with secondary shares? Seems like someone unhappy when theres an actual market and changing valuation instead of retirement funds ripped off by your banking buddy.

nemo44x2• 11 years ago

If you've been looking to place bets on early stage companies that can boom or bust - often for little to no reason other than trending with the sector, biotech in the public markets has been the place to be the last few years. It very much is resembling the .com boom in internet related technology.

RNAi has had some great moments the last few years in particular, and some spectacular busts and more great moments, for instance. But the public biotech sector as a whole has essentially been 1 big casino in the public markets. Even the ETF's are up a few hundred percent the last couple years.

I believe there's one more huge parabolic move before it tumbles - we'll see. Anyways, my point is we like to focus on the VC bubble in technology but the real "frenzy" has been in biotech IPO's and early/mid stage clinical companies even though private equity technology gets all the bubble press.

IndianAstronaut• 11 years ago

I worry that the basic science pipeline is drying up in biotech. A lot of good people are leaving the field due to erratic funding situations and generally low income and poor career outlook. I left my PhD in biology and many of my fellow PhDs, even if they graduated, are looking outside of the field for jobs.

RNAi is an example of something that was discovered 'by accident' from basic and exploratory research. To add, a lot of novel discoveries can be made from studying natural habitats and organisms(PCR for example) and many of those are disappearing. Making bets on biotech is making a bet on a field where long term prospects look poor.

nemo44x2• 11 years ago

Indeed, and a vast majority of early stage biotech's will simply contribute nothing. But then you get a story like Pharmasset which made any semi-early investor realize unbelievable gains in a very short period. But these stories are rare and it's pure speculation and the playing of market dynamics.

But yes, it is expensive research and although these companies have been able to find funding in the public markets due to a healthy appetite of risk for these types of things, I fear that when this obvious bubble bursts it will be very hard to find funding and a lot of research will simply run out of runway.

RNAi had a hot streak years ago and then had "dark ages" for quote a few years before it suddenly got hot again. And really the entire sector has been on fire. But I expect reality to take over soon and biotech will have some dark days ahead of it.

But for now, the casino chugs along.

fraserharris• 11 years ago

The lead example of FirstMark Capital is not new and its not a trick. A VC investment comes with pro-rata rights to invest in future fundraising rounds to maintain their % ownership of the company. A VC firm will allocate capital to a new portfolio company to follow-on in future rounds. FirstMark's fund is too small to utilize their pro-rata right in the late stage rounds of Pinterest. They have offered their LPs the option to use the right (which may be an obligation in the fund's limited partnership agreement). The "inside track" here is being an investor in a VC fund that funds a unicorn. Hardly a trick.

jacquesm6• 11 years ago

Anti-dilution clauses do not only benefit VCs, they're pretty common in companies of all sizes, with and without external capital.

In Silicon Valley Frenzy, VCs Create New Inside Track

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