Losing Money

[tedmiston]

Peter Thiel in Zero to One:

> The biggest secret in venture capital is that the best investment in a successful fund equals or outperforms the entire rest of the fund combined.

> This implies two very strange rules for VCs. First, only invest in companies that have the potential to return the value of the entire fund. This is a scary rule, because it eliminates the vast majority of possible investments. (Even quite successful companies usually succeed on a more humble scale.) This leads to rule number two: because rule number one is so restrictive, there can’t be any other rules.

[TeMPOraL]

Is it a secret though? I thought it's 101 of startups-VC interactions, and I learned it by reading pg's essays in about the same time I first learned what a "startup" is. I.e. the whole thing works because some people with money do high-risk investments in which nine companies out of ten fail, but the tenth one pays them back more than they invested in all of them together.

[ssharp]

Do most VC's think this way and is this actually a "rule", meaning it's the way you succeed?

I'd think VC investing is like most other types of investing where you can take on different strategies depending on your goal. Some investors will take large risk in order for large reward, where other investors would rather take lower risk for a higher probability of some positive return.

[dean]

> only invest in companies that have the potential to return the value of the entire fund

I have a feeling this is much, much easier said than done. How do you even determine "potential" of a startup, when, according to Paul Graham, "the best ideas look initially like bad ideas".

[shubhamjain]

Which brings to another unspoken rule of investments in general - "Looking at the history, every good investment looks good and every bad investment looks bad". Everything is explainable that occurred in the past but not with the information that was available at that time.

[Chris2048]

> only invest in companies that have the potential to return the value of the entire fund

No it doesn't. If the investment is likely to break even it makes no difference, or can at least reduce losses. So long as there is a certain, critical number of potential high-earners, compared to total investment, you're ok.

[disposeofnick9]

Yup, VCs tend to favor go-big-or-go-home ventures. There are also lots of seemingly tiny things that can be made bigger too... and those are better pitches/founders to astute investers like Thiel whom realize small people are all talk and big people understate themselves.

Reminds me of running into some tipsy Sequoia guys the night before the WhatsApp announcement... no lie, I knew who they were and what happened (figure it was a gigadeal) the second they walked in to a certain donut shop. It's definitely party-worthy when the fund is above water and all other exits are IRR gravy.

[andylei]

isn't this a self fulfilling prophecy? if i only invest in all-or-nothing startups, doesn't that mean that my returns are going to look like i only invested in all-or-nothing startups?

[db1]

I raised a small seed round (200k) on my first company. At that time I felt like it was a staggering amount of money. The company didn't work and out we pretty much lost all of it. For the longest time, I felt really guilty about how I had lost my investors money.

I have a little more perspective now and realize that it was practically insignificant to my investor.

Ah well.

[brianwawok]

Honestly I think it is good to feel guilty. If you felt 0 guilt and just shrugged, I think it would make you seem a little bit of a irresponsible sociopath.

Now obviously don't live in a basement for 6 months because of your sadness, it was an investment that they could afford to lose ;) But I think it normal / expected to feel sad/guilty when you let someone down...

[buro9]

It is indeed comforting.

We lost our investors 150k GBP, and I've been feeling guilty about that.

Investors invest what they can afford to lose.

[vthallam]

Tough luck! I have never raised funds and planning to raise funds soon, but back of mind, i do have fear of losing the investors money. I think the founders should get over this guilt as long as they were lean and did everything they could to save the company. Btw, How did your investors respond when it didn't work out?

[jerguismi]

> I have a little more perspective now and realize that it was practically insignificant to my investor.

Depends on the investor. There are probably thousands of VC's, and not all of them are comparable to union square ventures.

[tedmiston]

I think there's a similar founder guilt when founders go through an accelerator, but their company doesn't work out.

[rburhum]

At 200K, you were most certainly raising from angels and not VCs, so the returns are different...

[icedchai]

Look at it this way: Would you have felt better if you lost your own money?

[habosa]

Can someone help me do some math here? Take these sentences:

"It was all about five investments in which we made 115x, 82x, 68x, 30x, and 21x."

"In our 2004 fund, we invested a total of $50mm out of $120mm of total investment in our nine losers. "

OK so in the 2004 fund we have $70mm being invested in companies with rates of return between 21x and 115x. Let's be conservative and say the total return on that $70mm was 50x. That means 70mm --> 3.5B. If we assume that's the total return on the fund we get 120mm --> 3.5B.

I am now going to assume these returns were realized over a period of 10 years. So that works out to about 40% gains each year (compounded 10 times).

Is USV really making 40% every year for a decade? Are other VCs doing that well? I knew these funds were good investments but I didn't realize just how good.

[scott00]

No idea how reliable this is, but here's what Forbes has to say about USV's performance:

"66.96% IRR for its 2004 fund, a 38.88% IRR for its 2008 fund, a 29.04% IRR for its 2012 fund and a 61.44% IRR for its first opportunities fund" source: http://fortune.com/2014/01/24/union-square-ventures-raises-n...

[jimminy]

He also says they invested in 21 companies in the 2004 batch. Which means that 7 other companies returned negligible results.

Average investment per company was about $5mm.

So we can end up with:

$5mm * 115 = $575mm $5mm * 82 = $410mm $5mm * 68 = $340mm $5mm * 30 = $150mm $5mm * 21 = $105mm Total: $1.58B, about $1.5B after losses.

So that comes out toabout a 27% return, using the same math as you, before costs and management fees.

[mathattack]

The best VC firms do make that in their best years. VC is a strange field in that the winners have outsize performance, while the rest fight to break even. Unlike Mutual Funds and most hedge funds, the performance of top VCs persist over time too. Remember that this is a field that disproportionately rewards the winners. (Look at Google's early investors making 1000x [0])

The 40% isn't what investors see. Take away 2% per year for expenses and 20% of the upside and you're down to 30% for investors.

[0]https://www.quora.com/How-many-shares-did-Andreas-von-Bechto...

[morgante]

Your 50x assumption is probably overly generous, but in general yes: the best VC funds do have great returns. But we're talking about less than a dozen firms with returns that good and they're all heavily oversubscribed.

The average VC has a much less attractive return profile. USV is not your average VC.

[manuelflara]

Well, investing in startups is a great investment... when you win, like this fund which apparently gave out great returns. But of course, those investors could have also lost all their money. Risk and potential return always go hand in hand when it comes to investing money.

[olalonde]

On a related note, does anyone know why none of the big VC firms are publicly traded? Has that model been tried before?

[corin_]

The $70m is over 12 companies of which we know details of 5 of them.

[hullo]

They are not all that good. As he says himself, not even their other funds are as good as the 2004.

[nostrademons]

This can also be a good rule of thumb for entrepreneurs investing in ideas or potential new features, or even for ordinary employees managing their careers.

You can get surprisingly far in life simply by cutting your losses early. If you majored in art history, got to junior year, and then suddenly realized there are no jobs available - switch your major! Or transfer, if you have to. If you hate your job, find another one! If your skillset is out of date, learn whatever the new hotness is. If you picked a dead-end field that's being disrupted by a new industry, switch to the new industry.

Many people don't do this, because of a couple of cognitive biases: sunk cost fallacy and fear of the unknown. But they ignore that they've learned new information in whatever their old role was, and that the future is usually much longer than the past.

[dgant]

Plus https://en.wikipedia.org/wiki/Effort_justification

[yesimahuman]

Not to mention the social pressure to never give up or quit anything. A lot of people would do well to quit and move on from something that just isn't working.

[karterk]

This also explains why VCs look to fund billion dollar opportunities even if they look a little risky. VCs are in the game for big exits and that's how the math works out.

Something to keep in mind when you're planning to raise money.

[90002]

I think entrepreneurs often forget that VC's are deploying OPM, which puts an enormous amount of pressure on the firm to deliver outsized returns. I've met a few entrepreneurs over the years that fail to understand this fully - sad!

[colinbartlett]

It would be awesome to see a list of the winning companies and the approximate multiple on invested capital returned for each of them, along with which companies fizzled out.

Not expecting to ever see that, but it would be interesting to learn which ones they thought would be huge successes and what the eventuality was.

[eastdakota]

USV's 2004 fund invested in Twitter, Tumblr, Indeed, Etsy, and Zynga. Those likely represent the 5 double-digit return multiples Fred references. It was an astonishingly good fund — certainly among the best of its vintage and perhaps among the best of all time.

[tedmiston]

Is there a technical meaning when he refers to fund years as "2008 vintage" vs. just "2008"?

[joncrocks]

Not beyond what you'd probably assume it to mean... http://www.investopedia.com/terms/v/vintage_year.asp

[debacle]

The fund is labeled 2008 but they invested in opportunities over the course of several years.

[adewinter]

I suspect it's more of a pompous thing. Thinking of the funds like wines: they mature/get better with age.

[xpda]

It's risk/reward. Whether a VC fund, NYSE, or government security, you can risk more for greater reward. This does not mean, as the article implies, that you should. It depends on the individual and the purpose of the investment. I can probably make a lot more money investing in a riskier company, but I am also more likely to lose some or all of my investment.

If I am considering investment in a fund that expects a 40% annual return, I should remind myself that if it was a sure bet, then enough people would be investing in it to drive the price up and the return down. There are plenty of investors as smart as me, and many of them are willing to do more research than I am.

[elmar]

The Babe Ruth Effect in Venture Capital

http://cdixon.org/2015/06/07/the-babe-ruth-effect-in-venture...

[baccredited]

I'll summarize: Many startups fail. Don’t throw good money after bad.

[sakri]

Why does he use mm ($25mm)?

[hackaflocka]

> I am a big believer in “loving your losers” in the sense that you should not orphan them and you should work hard to get to the right outcome.

From the guy who talked about cutting off losers early a paragraph ago.

[paulpauper]

My 'fantasy VC' scorecard since 2008 is nearly perfect, having hypothetically put money into snapchat, air BNB, Uber, and Facebook. Picking the future winners from the losers seems very easy, but the problem is if everyone did this strategy many companies would go unfunded. Just simply funding companies that are already big and growing rapidly and riding the momentum, seems to guarantee the most consistent returns. Investing in tiny startups seems not worth it since the expected value is not high enough and the liquidity is probably poor.

[greenspot]

Nice write-up, would have loved to know how your current fund performs and who are the losers now.

[sz4kerto]

Note: Ben Graham wrote about all these decades ago. (It doesn't make this article less true, etc. -- just if you're interested in these basic rules of investing, then read 'The Intelligent Investor'.)

[homero]

Good thing he's got bitcoin to fall back on when the vc bubble pops

[dataker]

Why would anyone feel guilty about losing money from a VC?

In the end, it's a venture capital FUND: risk and return are inherent to this. It's not the VC's money, but a collection of GPs (themselves have thousands of individual investors).

Your loss is already accounted for in their portfolio. Otherwise, they're not doing it right.