Venture Capitalists: Not Gangsters, but Gamblers


Thanks to a very thoughtful comment by Fools Gold in an earlier post, I’m again really wondering about the math of the VC biz.    Venture Capital for startups appears to be a game that is generally misunderstood by most as a sort of insider mafia “cash machine” for the rich when I think the evidence would support the idea that startups are a losing bet on average and are for the most part the product of honest dealings rather than back room gangsterism.  

After a Don Dodge article I think it was Jeff Clavier who told me that only about a fourth of VC firms were delivering positive returns – that was about a year back I think and I know Jeff was doing very well with a lot of winners – he was NOT talking about his own great results.   Fred Wilson was also getting very positive returns for his firm, though I remember he was giving enough information about the time frames to get a good sense of how good the returns were.     A key filter of course is the fact that firms with negative returns are hardly going to be blogging much or advertising that fact.

How to derive valuations?  For new companies it is close to anybody’s guess.   I think the market makers are driving pricing in very unnatural ways that look more like casino gambling than thoughtful investment. As I’ve noted before most VCs actually appear to *lose* money on average.

The game is certainly not “rigged” the way many think it is and my working hypothesis is that VC for startups is sort of like Arabian horse farms – it loses money for most but is a very fun hobby for many who effectively build relationships and contacts that help maintain their wealth and control over things indirectly. Sounds ominous but this is actually a pretty functional environment because it keeps the best innovators well fed and productive even as their startups mostly fail at the expense of people who can afford to lose a few million here and there in exchange for the fun of an infrequent big payoff.

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About JoeDuck

Internet Travel Guy, Father of 2, small town Oregon life. BS Botany from UW Madison Wisconsin, MS Social Sciences from Southern Oregon. Top interests outside of my family's well being are: Internet Technology, Online Travel, Globalization, China, Table Tennis, Real Estate, The Singularity.
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3 Responses to Venture Capitalists: Not Gangsters, but Gamblers

  1. Clay Burell says:

    Hi Joe,

    Sorry to post this non sequitur comment here, but found no contact link. Please see your Flickr messages about my attempts to help a couple of good Korean high school kids find a suitable homestay situation in Medford.

    Thanks much,

    Clay

  2. horatiox says:

    The game is certainly not “rigged” the way many think it is and my working hypothesis is that VC for startups is sort of like Arabian horse farms – it loses money for most but is a very fun hobby for many who effectively build relationships and contacts that help maintain their wealth and control over things indirectly.

    Interesting observation, yet I tend to disagree, while granting that proving the “game is rigged” (or to what degree the game is rigged) would require a great deal of legwork. Google, for example, shows how the modern technological corporation takes shape. It’s started by two bright-boys attending stanford U. Steinford may not be the headquarters for La Cosa Nostra, but few would deny that a sort of country club atmosphere exists in Palo Alto (at least west–east P.A. is now ghetto, baybe), which caters to the well-to-do.

    A few kids from the wrong side of the tracks get in to Stanferd, or UCs, Ivy League, etc, but I suspect if you did a bit of research you would find that most of the dweebs (or dweebettes) entering Stanferd U and top-level schools were from wealthy, or at least upper-middle class families.

    The corps seem to feed off of, and grow out of the top-level universities. At the very least, Page and Brin happen to be in the right place at the right time. Many high-powered scientists and programming people work and live around Stanford (and Silicon Valley of course), AND there is capital: industry and business needs its propeller-heads as much as it did when Carnegie made use of engineering advances in the processing of iron and steel to establish US Steel.

    It’s not like Googles (or yahoos, or microsofts) begin in Joel Turnipseed’s garage in his home in Reno. Bill Gates himself comes from Harvard: old money, then. So while granting it’s not mafia in the sense of AL Caponay, they do take shape in a certain intellectual–and financial– context which some cynics might term a racket, or following Galbraith, an oligarchy of some sort.

  3. JoeDuck says:

    Horatiox I think you have done an excellent job of describing how the tech biz is a kind of oligarchy, where wealth begets insiders and then insiders groom each other.

    However I’m noting that rigged or not most VCs, on average, are losing money. Money flow is negative in startups based on my limited research, so this is probably a good thing in that although Joe Sixpack is deprived of the chance to hit a home run with an insider play he’s also unlikely to have a chance to lose money betting on startups, most of which will fail.

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