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.