Dumb money?
It is hard to not get jaded after being in the trenches of super early stage investing as long as I have been. I have been doing my own investing for over a decade but I have also been watching, learning and listening to my husband invest for 30 plus years. The stories I can tell.
I have witnessed the good times and the bad times because we have gone through a few cycles, the big ups, and the big downs. Obviously, the ups feel much better but the downs are the biggest lessons learned.
What has never changed is dumb money. Dumb money is a broad category. There are the people who think that investing in companies is easy and you can just put capital into a young company with a supposed good concept and by doing nothing it just magically grows because isn’t that what is supposed to happen in the land of start-ups? There are the companies that get backed by huge amounts of capital at absurd valuations and end up gasping for breath because their vertical valuation isn’t equal to what their revenue intake is.
There are the investors who grow outside of their sweet spot because they can and start to invest at later stages and appear to have lost their touch. There are investors with huge pockets of capital that feel comfortable giving a large amount of capital to a founder because, in the end, they really don’t care if it doesn’t work out although it would be nice if it did because they have other darts out there. There are the investors’ with a thesis completely out of line with the founders. The investor knows that one big hit will make up for all the bad investments but for the founder, not succeeding is devastating.
I have given up trying to understand why some companies get funded and others don’t, why investors invest in what they do, why valuations to some don’t seem to be as important as it is to others, why some investors just give out capital and don’t do the hard work of helping companies grow, why some investors just follow other investors like sheep, why some investors don’t have a thesis. Perhaps if it all works out in the long run, and investors figure they will be able to pay their LP’s back a decent return, then they don’t care. I don’t know the answer.
What I do know is that change is coming. More founders are figuring out how to get profitable sooner and more savvy founders are interested in smart money, people who can be of help and get their business. There is a ton of cash out there right now and lots of it just feels dumb.
Comments (Archived):
The world is awash in capital, until it isn’t. On the trading floor we used to say that the exit door looked really big until 50 fat men tried to get through it all at once. It looks easy from the outside until you do it.My mantra is to treat someone’s portfolio like you do a friend’s hunting dog. You never criticize another hunter’s dog. You don’t know why they picked that one out of the litter.
Lol
If you think you are seeing a lot of dumb money, then head over to the crypto side, where it is more the norm than the exception. I wrote about this actually yesterday in my opening paragraph here:http://startupmanagement.or…Another thing is that dumb money tends to be louder.
You have to be louder if you have dumb money.
yup.Dumb money isn’t going to the smartest entrepreneurs.
and more savvy founders are interested in smart money, people who can be of help and get their businessI think the short way to summarize this phenomena is that quality is a niche product (or service) and not mass market. My point is that this goes for most things out there (whether goods, a service, or in this case investment money). People buy (en masse) based on price (usually) and not based on quality but more importantly the total value proposition. You see this in just about everything out there. People make simple decisions and are easily fooled. Primarily because they follow what others do as a rough guide and/or don’t have enough experience to see things differently.There are the people who think that investing in companies is easy and you can just put capital into a young company with a supposed good conceptThe saying that I have for these types of people is that they ‘want to wash the suds off the car’. That is named after people who wanted the easy part of the job ‘washing the suds off’ while watching me as a kid waxing and washing cars to earn money on the side. They didn’t want to do the hard part (getting the customer, washing the car, drying the car, the waxing) they wanted the fun and easy part ‘washing the suds off’.A good proxy for how much someone is in to what they are doing is to see the types of jobs they are willing to do to get there. If they want the fun and only the glory but won’t clean the bathroom then they are ‘wash the suds off’ and stand a lower chance of success. (That said it does happen as you know in some cases..)
Ok, but what if Albert’s “world after capital” is right and the likes of crowd funding and shifting economies makes early cash easier and that’s just normal now. That could be going on, too, and at least where I am, I don’t see many folks caring where the initial money comes from. I hope you are right and I am not!
I hope I am right too. Initial capital is also friends and family. It is the next two rounds that are shifting.
I started my career during a recession in the early 90s, witnessed the aftermath of the dot-com bust, and got upfront and personal with the credit crisis. There is always a lot of money kicking around looking for a home. The start of a cycle features active participants that roll up their sleeves and do more than just provide capital. The participants change over time, opportunities flip without much actually changing fundamentally. Some people get lucky – really lucky. Others keep plugging along and survive the down cycles because they have some form of operational and entrepreneurial expertise. Others suffer and sit back waiting for the market to “come back”. It can be alluring to get sucked into the high-risk, got lucky, got rich stories (I heard several over the weekend. Here in Vancouver, Canada, it usually involves bitcoin or real estate.) But I remember to stick to my knitting because it is the entrepreneurs (be they entrepreneurs in the investment industry as well as other industries) that survive and thrive. Know-how matters (sometimes more than capital or capital follows know-how).
Know-how definitely matters!
There are no free meals in life, neither to founders nor to investors. If it comes too easy, caveat emptor…
That whole second to last paragraph, but from the founders perspective. The emotional landscape of fundraising is walked on a tightrope whereas you have to be emotionally committed to go out on the rope, but being distracted at other companies inexplicable success/failures *in fundraising* can make you fall into a pretty dark place.
Yes it can
Amen sister Wilson.May I add: I think a lot of the cloudy incomprehensibility dissipates when one considers that the vast majority of professional investors get rewarded handsomely whether or not their investments do well. Forget pay for performance, most GPs get paid to fail. Or muddle along in mediocrity.To wit: Ridiculously big management fees immediately skewer alignments between GPs, LPs and portfolio companies. GPs get 20-25% of a fund just to lavish on themselves, regardless of whether they invest in Google, or Theranos. Plus, while I readily admit that long long contracts are necessary in venture, such allow GPs to raise new funds way before their previous funds can be reasonably measured for performance. The result is a massive fee sucking economy, disconnected from portfolio companies and founders (and LPs.) Making it even crazier, the day in day out management at LPs changes much more rapidly than fund returns can be measured. So the person who works at the endowment or family office or wherever is almost certyainly never around when their fund choices get reasonably measured for performance. The result is even more fee sucking. Investment committees make asset allocations then hand off the numbers to professionals who do their best, but don’t ever get compensated based on the real results of their choices. Hell, imagine if fund GPs could only get management fees equivalent to what their portfolio companies spend. salaries, of say $100K-$300K. Rents that buy great offices, but not the insane money palaces most funds live in. Imagine if GPs had to submit annual operating budgets to be approved by LPs, as GPs require of their own portfolio companies.Yes, I know, I ranted about this stuff on AVC for years.And you may say I’m a dreamer! But I’m not the only one…. 🙂
Love seeing your rant here!!
At our fund, we give back management fees before we see a dime. It aligns us with LPs. Also entices us to keep management fees/costs extremely low.
That sounds good. Do you mind if I dig a little? For example, are you talking about “seeing a dime” in carry? If so, what if there’s no carry? What if the fund returns 0% returns? Do you keep the management fees? If not, how do you “give back” fees?
Sure, let’s keep the math simple. Say it’s a $10M fund with a 2.5% mgmt fee and 20% carry. All the companies exit, fail etc and we return $20M. Waterfall-> 20-10=10-1.25=8.75 gets split 80/20. All LPs get their entire management fee paid back before any splits. We also have set up some sidecars that pay 20% to all LPs with 0% mgmt fees. (We also are invested in our fund with our money)
Respectfully, I’m not sure that addresses the imbalance I’m pointing out.To wit, what if your $10M fund returns $10M? Or $8M?Even in the example you cite, should there be any split at all? For me, in that example, the GPs should keep their management fees … they did work on the fund after all… but the fees should be much much less. That is, the example shows how exorbitant the fees are and why they should be reduced: 2.5% per year of committed capital (not called capital, a common mistake observers make when considering fees!) means that over 8 years 20% of the fund goes to the GPs as management fees! 20% of the fund! For me that’s nuts. I mean, that alone makes GPs job producing above market returns almost impossible. They are investing only 80 cents of the dollars raised, meaning their returns have to be nearly 3X cash on cash just to beat the S&P500. Crazy! GPs should submit operating budgets for their costs. Just like portfolio companies do.(And yes, it’s hard to imagine a $10M fund supporting GPs at 2.5%/year so GPs would have to argue they need more. Or else live with tiny management fees and subsidize from their own pockets while they launch their firm — presumably the goal with a $10M fund.)But also, your example misses the mark by starting out with a hypothetical $10M fund. Let’s use a $100M fund example. $2.5 million in fees every year for eight years! Really? Maybe 2 GPs, maybe 3, with a fund that size? That’s kingly fee compensation not linked to performance at all and unreclaimable unless the fund actually produces positive returns, which unfortunately, many don’t. It’s way too strong an incentive to focus on artificial portfolio markups followed by new fund raising, followed by mediocre returns. It’s why many VC firms live for so many years despite producing thin if any returns to LPs. And it’s why investors like Joanne, who does not operate on a fee basis, see so many incongruities and misalignments in the marketplace.My $0.02. Well, maybe $0.03. Thanks for listening.
Fund size matters. I wouldn’t be against your idea of a budget.But if you don’t return the fund you aren’t raising another. So your example of $8M doesn’t work. The Mgmt fees only lasts for 5 yrs as well (for us anyway)The LPs also take a risk on the VC team which is why we get vetted etc. A GP should not be a commodity.Larger funds also have analysts assistants etc to pay As an LP do you want your GP doing tasks like that or is time better spent looking for and working on existing deals?You could do a different model of 0% Mgmt fees and more carry but then how would new people break in to VC? Or 100% carry to LPs but again you’d have higher Mgmt fees to attract talent.There are costs to running a fund that are not apparent. Legal audit and fund administrationYour point imost funds not doing well illustrates why there is such competition to get into top tier funds. LPs make educated guesses about which new funds can become a top tier fund.Recycling fees is a good idea
i think you and i are in general agreement. however, many managers of funds which don’t return the fund or perform poorly raise new funds. because most funds get marked way up in their early years through new funding rounds, so GPs raise new funds based on that, while the ultimate returns aren’t known until years later. i’ve seen this personally several times (as an LP)btw, i applaud that you only collect management fees for five years but you are an outlier. most funds collect management fees 8 years. or even more…thanks for your generous friendly discussion
We are in general agreement. I am very appreciative of your comments and sentiments.I know funds that aggressively do stuff with the fund in mind, not the entrepreneur. For me, I don’t have to do this. I choose to do it because I like it. I could walk away and go fishing. At the same time, you do need some money to operate. No one should be able to retire and get rich off management fees. Also know funds that write small checks which won’t return any money but at least their ego gets satisfied by having the company’s logo on their tombstone.We made a conscious decision. Our customers are the LP’s that trust us and the entrepreneurs that welcome us into their deals. We are very deliberate with them, and transparent with them. Our mission is to make money for our LPs and make sure entrepreneurs make money too. I like to say that I hope they buy and island and I can buy a Porsche that fits me.