So I am a Silicon Valley outsider. I live in the northern EU and work with project management in the construction industry representing the owner. It’s mostly infrastructure, roads, water. Old industry, conservative, we basically hate new things. On my spare time I tinker with my computer, learn assembly or whatever. Hence HN.
I have recently started a course in corporate finance at my local uni because my new role requires me to understand accounting, making business decision and so on.
I haven’t finished my course, and I have to admit that I skimmed the article. So what I am about to say is probably wrong. It’s a feeling I have.
I have the feeling that a lot of theses articles are pretty basic corporate finance. What I mean is that if you study and try to understand basic CF, you will gain the insights that many of these articles talk about.
When I then read in the comments that there are cases where tech leads with no business experience get millions in funding and basically are learning by doing. Silicon Valley seems to be on another planet for me. It’s sounds surreal to me.
If I was an investor I would never give that person money since projects are so extremely difficult. The wicked problem is a real thing. Or maybe I am just poor and don’t get how people with large amounts of cash think.
I get that it’s a numbers game and you have a portfolio of companies, but still.
Guys that are closer to SV, I would love to hear your thoughts on my thoughts.
When investing in different industries (construction vs tech), it's often useful to think about them in the context of asset classes.
Specifically, construction is more tied to either real estate, hospitality or government contracts. These often raise money via a bond (debt) offering or an equity with a very well-worn finance model. These projects require a lot of upfront capital (billions not unusual for roads) and have long time horizons, with log() or linear returns, and have a very well understood model for packaging as a risk asset. These risk assets attract a certain kind of investor, or a certain risk profile in a large fund's portfolio.
Venture capital as an asset class is a bit different. The expectation is that an idea can be proven out relatively cheaply, and the business will scale since the major leverage is intellectual property (vs physical assets). The expectation is also that most business will fail, with maybe a handful of successes capturing most of your return. VC's investing in startups with risk-appetite LPs, is very different than a real estate developer going to a large bank to build a housing project. The VC model is closer to investing in a TV show than a construction project.
Put simply: Investing in a moderately sized government construction project ($2b or so for a toll road in latin America) is a totally different finance product than a startup that leverages IP. The aggregation of risk is also different (VC vs say, REITs) and the devices are different (equity vs debt / leverage). Most investors either run a balanced fund at a large size, or specialize, since they are so different.
EDIT: Also important is relative size of each investment asset class. VC is hilariously small (222 billion in 2022) in comparison to something like energy (2.4 trillion in 2022). VC gets a lot of press but for most professional investors "real funds" start at about a billion table stakes.
This doesn’t answer OPs question, IMO (or my interpretation of what OP was saying is wrong).
Sure, construction and high-growth tech startups are different investment opportunities. They have different risk profiles. As someone managing money, shouldn’t you be looking to mitigate risk to maximize returns? Why give money to the startup which has an idea and no experience running a business, managing capital, accounting, etc.? Wouldn’t money be much better spent on a startup that had all those things?
I have heard in the past that the majority of startups fail, and that successful startups are often founded by people who have founded (often unsuccessful) startups before. When looking for a company to invest in, shouldn’t these be top priority? I don’t buy that VC and high growth companies need to be as risky as they are. I suspect a lot of it is bad decisions and lack of due diligence.
> I have heard in the past that the majority of startups fail, and that successful startups are often founded by people who have founded (often unsuccessful) startups before. When looking for a company to invest in, shouldn’t these be top priority?
If they already are, either directly, or because “founding a startup” (as if it doesn’t get funded, its not really a startup) is heavily dependent on connections from the beginning, that would explain the effect itself.
You beat me to the follow-up! I actually answered this below. I'll address it directly but it may get flagged as copy / paste so apologies in advance.
> As someone managing money, shouldn’t you be looking to mitigate risk to maximize returns?
- Asset classes aren't just about returns, they also have other dimensions like volatility ("beta"), liquidity, correlation, and time horizon. Being able to sell something easily is valuable, and not being subject to crazy swings is also valuable. Unfortunately those two often are at odds. These features make for different investment mixes, and also affect how you can get leverage (loans) with them as collateral. Specifically, real estate is super easy to get a loan on since it's not very volatile. Pre-IPO startup shares are very hard to get a loan on, because they are both volatile and illiquid.
> Why give money to the startup which has an idea and no experience running a business, managing capital, accounting, etc.?
- Companies that have physical assets often have a focus on operations work (e.g., where do I economically source asphalt near Berlin?). Intellectual Property businesses often have a focus [exclusively] on product work (e.g., what new software feature does EMEA sales need to make their quarter?), where accounting, etc is less correlated with outsized outcomes. One is quite literally, building the value mile by mile at a relatively high cost. The other is more "unlocking" value that was so unbalanced something with minimal physical footprint can access it.
> Wouldn’t money be much better spent on a startup that had all those things? When looking for a company to invest in, shouldn’t these be top priority? I don’t buy that VC and high growth companies need to be as risky as they are. I suspect a lot of it is bad decisions and lack of due diligence.
- Ideally you have all those things, but sometimes you can't get all the things in a deal and shaping it is the value you provide. For non-public investments, a lot of the value is from either shaping the deal yourself or getting access to the right people. It's easy for me to invest $1000 in GE. I can't just walk up to Pixar and ask to invest $1000 in their next film. Same is true for startups. You either need to seed the deal (be the lead investor), or have the access to contribute. Building these relationships is a lifetime of work. This is why people specialize.
- Adding to above, VCs themselves are even more specialized, and different stages require different balances of due diligence vs speed. VC's typically stratify by company stage (seed, A, B, C, mezzanine, etc), industry, geography, thesis, etc. These are often driven by the philosophies of the partners, fund size, or by the LPs with specific expectations. To give a very direct example, GV with exactly one LP and invests in A-stage or later, has very different goals than YC, which has very different goals than the venture arm of a big-12 pharma company like Roche (Pharma is also intellectual property based). It's specialization all the way down.
Unfortunately, I picked most of this up from school (shout out to Babin's Engineering Entrepreneurship class @ Penn) and from my stepmother who is a capital markets attorney.
However the two finance podcasts I follow really closely are "Odd Lots" from Bloomberg [1] and "The Compound and Friends" from Josh Brown and Michael Batnick. Both take a more broader look at the economy than just venture capital, and are super smart folks. Also honestly, they're fun to listen to which makes it easier.
No problem! Some other thoughts I had after thinking more about your question.
- Companies that have physical assets often have a focus on operations work (e.g., where do I economically source asphalt near Berlin?). Intellectual Property businesses often have a focus on product work (e.g., what new software feature does EMEA sales need to make their quarter?). One is quite literally, building the value mile by mile at a relatively high cost. The other is more "unlocking" value that was so unbalanced something with minimal physical footprint can access it.
- Since outcomes in IP are so binary, it winds up that having all the ingredients geographically focused produces the best outcomes. This is definitely true for talent, but also the money, risk appetite, specialized services, government, etc, all contribute to the ecosystem. This is why SV (tech) and LA (media and entertainment) exist. By comparison, NYC is still large, but is a deep secondary (1/10th the size) for both industries.
- Asset classes aren't just about returns, they also have other dimensions like volatility ("beta") and liquidity. Being able to sell something easily is valuable, and not being subject to crazy swings is also valuable. Unfortunately those two often are at odds. These features make for different investment mixes, and also affect how you can get leverage (loans) with them as collateral. Specifically, real estate is super easy to get a loan on since it's not very volatile. Pre-IPO startup shares are very hard to get a loan on, because they are both volatile and illiquid.
- For non-public investments, a lot of the value is from either shaping the deal yourself or getting access to the right people. It's easy for me to invest $1000 in GE. I can't just walk up to Pixar and ask to invest $1000 in their next film. Same is true for startups. You either need to seed the deal (be the lead investor), or have the access to contribute. Building these relationships is a lifetime of work. This is why people specialize.
- Adding to above, VCs themselves are even more specialized. VC's typically stratify by company stage (seed, A, B, C, mezzanine, etc), industry, geography, thesis, etc. These are often driven by the philosophies of the partners, fund size, or by the LPs with specific expectations. To give a very direct example, GV with exactly one LP and invests in A-stage or later, has very different goals than YC, which has very different goals than the venture arm of a big-12 pharma company like Roche (Pharma is also intellectual property based). It's specialization all the way down.
One of the classics that explains the why behind VC backed tech companies is Peter Thiel's book Zero to One.
A big takeaway for me from reading that book was that the companies that become extremely profitable are basically monopolies with no or few competitors that focus on scaling up rapidly. That was counterintuitive for me because I would have thought you'd ideally want to be profitable at all times. I'd also assumed that competing against incumbents that have little or no competition was the best way to get a profitable business running. That's actually a bad idea unless you're at least 10x better than the incumbent which you probably won't be.
> a lot of theses articles are pretty basic corporate finance
One take: yes, and venture-backed companies often forget or ignore the basics of corporate finance.
Another take: orthodox corporate finance isn’t tailored for start-ups. If you’re developing a product, GAAP income is meaningless. So we bootstrap interim financial metrics, e.g. eyeballs and ARPUs and DAUs (oh my!).
In truth, the latter dominates at the early stage. But firms grow. Some founders and VCs (see: Andreessen) are late to recognise when nontraditional metrics do more harm than good. When that ignorance becomes a point of pride, the former gains explanatory power.
Somewhat. But even if you (perhaps rightfully) roll your eyes at startup growth at all costs approaches, the thinking around cash flow at a VC-backed startup should often be different than that of a florist funded by savings, a bank load, or friends and family.
> they should be acting like a small business e.g. florist
Small businesses and startups are delineated by scaling potential. Running a startup like a florist is ruinously-bad advice. Just as running a small business like a startup is stupid.
And even a florist looks, either explicitly or implicitly, at the same things. As soon as a company reaches a certain size, measured in employees, funding or revenue, you need at least the basics of corporate finance.
I'll add to this a quote that is (purportedly) native to gp's northern EU: "Do you not know, my son, with how very little wisdom the world is governed?"
Difference is that corporate finance is focused on managing a company at its current size while startups are really focused on building a much larger company. Hence why the economics of it make no sense until it hits that mythical future size
> corporate finance is focused on managing a company at its current size while startups are really focused on building a much larger company
Circa 1810, maybe. Since the railroads corporate finance, particularly American finance, has been focussed on growth. Hell, the term venture capital pays homage to the financing of merchant vessels on high risk / high rewards voyages.
I live and work in Silicon Valley, and I agree that the concepts in the article are pretty elementary and critical to understand in any business, not just tech.
However: if your software product has struck gold, it will have “rocket ship” nearly-free growth and negligible incremental costs. In that regime, only the top line really matters. This is the kind of home run that many people are looking for in Silicon Valley, both founders and investors, which explains the relative “traditional” financial illiteracy in startups around here.
Yes, articles like this seem rudimentary to folks with MBA/accounting backgrounds.
Yes, tech startups can get millions in seeds funding, even where the company doesn’t have a CFO (or anyone with an MBA).
However, at those super early stages for sw startups, it doesn’t really matter. The money is to finance a product, prove the product’s value, and build a team. And its that journey where that company may start looking for a CFO.
By the time that company is raising a series A, they should have these things worked out.
Most innovation of internet and computer-related business come from Silicon Valley, so it seems reasonably clear to me that investors there are doing the right thing. To be honest, I find it hard to name any highly successful EU companies whose main business is internet-based or software-related, at least not in the b2c sector. There are some, but the major players seem to come from the US and more recently also from China.
I've always considered the risk-averse investment culture and bureaucracy in Europe to be a major factor.
And Spotify is a piss poor business, has never been profitable and its costs scale directly with its revenue.
It’s contractually obligated to give its suppliers 70% of its revenue and its major competitors consider its whole reason for being just a tiny feature.
A feature that IPOed and is currently with a market cap of $24B. Please let me know where I can invest in more of such features, because the ROI is huge.
So now the idea of a successful company is “what it IPOd for” not “whether it makes a profit”?
Spotify had a market cap of $26 billion at IPO. It’s now worth $24.2 billion. If you had bought the stock at IPO and held onto it your ROI would have been negative. The VCs and investment bankers would have counted you as one of “the greater fools” (https://www.investopedia.com/terms/g/greaterfooltheory.asp).
By comparison, the S&P 500 is up 50% since Spotify’s IPO
This is a discussion on VC investment strategy. So the question is more like: if you invested in Spotify series A or B and exited at IPO did you have a good RoI? The answer is yes, you had an extremely good ROI.
> My bootstrapped mobile gaming company achieved success…
He was specifically talking about a company not getting VC funding and “growing profitably”. In the last decade or so, I can’t think of one tech company that was profitable before it IPOd.
A lot goes into making a product that people love, if you can master the customer, market dynamics, pricing, pitch, product, service, etc to be growing really fast, you can probably learn basic corporate finance. That's what the VCs are betting on and they will even give you a board member and resources to help you out! if your product is only successful because your unit economics are upside down which is giving an unfair market advantage where you have none otherwise, well then that's reckless
My understanding as someone who worked in SV is that there’s a lot of buzz in the area around new technologies and people are always doing something interesting/revolutionary/whatever. There are investors who diversify their portfolio by investing in multiple high risk high reward investments like these startups. So even if you invest in 100 companies and 99 fail, the one that succeeds might be that unicorn that pays off.
Concurrently, there is a greater understanding that waterfall engineering is not the best for software. Instead, software is more agile, in that you build test prototypes and have a tightly integrated feedback loop instead of huge project plans that take months to even reach market.
The philosophy is more around testing market hypotheses quickly and iterating quickly.
Another factor is there is a lot of hype around SV that forms a positive feedback loop. Of course investors are not so easy to part with their money but it is inclining towards gambling in some fields flush with capital.
This is not true for all fields in SV though, for example in the biotech and medtech field, getting investment is much harder from my experience, as there are more regulatory factors, higher barrier to startup, longer time periods for outcomes, etc.
As you may have realized, basic corporate finance is not that hard. It's totally doable for tech founders to learn by doing -- and savvy investors presumably give them sound advice and make sure they're on the right track. They'll also usually get somebody with business/finance experience to join if/once the product gains traction. The value founders provide is usually bearing the risk and effort in developing the "new product", while anyone with a MBA can deal with the business/finance side of things if needed, so the latter might be viewed more as a commodity.
But then, as we've seen in the FTX fiasco, some investors really just throw money around without any due diligence.
There's an angle to consider – why is it that people who are technically skilled and financially experienced do not take on venture funding and build billion dollar plus companies? [1]
Perhaps, they know (from business experience) that the VC treadmill is not in their best interests, when everything about that life is considered! :)
Perhaps investors actually benefit from the naïvete (read: not incompetence, just naïvete) of their portfolio companies?
It's a symbiotic relationship, but there's a reason that the road between founder and VC is generally a one-way street.
[1]: There are notable exceptions to this observations. They're worth understanding, too.
Let’s say you distribute X million € to X startups (each one gets 1M) and you know that on average one of them will yield 2X in 5 years and the rest will just burn the money and die. This seems to be a good investment, right? You only need to pick those startups carefully. It appears, the criteria of selection may be quite different from what you would look at if you were to provide those money as a loan. I’m not sure how VCs really make their decisions, but this is just a case of having a good risk model based on variables that matter the most.
x > 2 means you've lost more than your investment in five years. You've going to need a startup to return X million dollars to break even.
> You only need to pick those startups carefully.
This is the "draw the owl" moment. The top comment is saying that they wouldn't pick any startup that didn't have someone to understand basic corporate finance.
You might be misinterpreting. His nomenclature is misleading, but he doesn't mean "2x", he means "2X", where X is the number of companies. That is, you give 1 million € to 10 companies, and the one winner makes you 20 million € (20 times what you invested).
He's saying you are guaranteed to double your money in 5 years, which for most investments isn't easy. Or maybe you understand this, and mean that a VC firm needs to target even better returns than this to stay cover their costs and stay in business? Possible.
I don’t know if every VC had an unicorn at least once in their portfolio, but for early stage investments to be a good idea they just need to beat consistently any other investment opportunities.
You say it’s difficult, but you yourself will learn the key principles from a single course.
Learning to create a successful product is much harder and requires a much rarer set of skills. There’s no course you can take that will give you this ability. Knowing lots of details about accounting and business administration won’t help you unless you can make something that sells.
Your observation is not wrong, and it’s part of the reason why so many of these startups lose money. However the element I think you’re overlooking is the distribution of potential returns. If you invest $10m into a a startup, maybe you lose $10m or earn $250m, vs investing $1b into an infrastructure project and maybe making $200m or losing $200m…
In some cases, your goal as an investor is not to hold on to the investment until it becomes a viable company and IPOs. Instead, you just try to sell your shares to the next person as quick as possible.
If you're in the latter situation, then hype is way more important than actual fundamentals.
Think of it like this. If you're a big fund you want a portfolio diversified in industry and risk.
If the guys CalPERS allocated the 0.5% (a few billion) to (the VCs) decided to also not do the risky thing then you haven't got a diversified portfolio.
The point is to put a small amount of your phenomenal wealth into risky bets with outsize returns precisely because you want to capture some of that other risk diversity.
At the beginning of a company, it's all hope anyway [1].
Investors are sophisticated enough to quickly reason about basic margin opportunity, and decide if the company could ever be profitable, even if the founders have no real business experience. The assumption is that by the second round or so, you can refine the estimate of "Could ever be profitable".
More importantly for venture capital, is that there are many profitable businesses in the world that have people with finance expertise. If you just wanted to invest in profitable companies, you wouldn't be doing venture capital. Instead, you're seeking companies that will have massive returns and become profitable some day.
If the founders still don't know how to do finance, but they're making a ton of money, you send them a CFO to tighten that up. Same way you send them names for VP of Sales, or whatever else they need.
Deciding to give up on a company that seems to be generating lots of money, and "just" needs to improve margins is hard. If you tighten too early, you've blunted growth. If you tighten too late, you've thrown away the money. For the last few years, the amount of money sloshing around meant you saw more of the latter. The firms "had" to keep investing their funds, so they were chasing more and more deals on hope. But $10M out of a $1B fund is still no big deal.
tl;dr: the rare thing is rocket ships, not financial sophistication.
Google’s initial VC funding round pre-IPO was something like $25m. Even allowing for inflation you see that kind of money tossed around on pre-revenue NFT startups based on a pitch deck today.
Okay, as someone who has lived in the "heart" of Silicon Valley for a few decades I'll take a shot at this.
To be fair, I didn't appreciate how unusual it looked until I helped a friend start their business in Illinois and saw what they dealt with at a bank.
You are correct in your assessment that articles like the one linked here are pretty standard business explainers. The interesting thing for me is that it really is just math and systems so it "should" be interesting but for a lot of folks they don't seem interested and just want to sell product.
So at least part of the venture community has convinced itself that it knows how to "productize" anything, if they just had something to work on. And along comes a person with an idea and hope. The venture capitalist (VC) thinks, "I'll provide the business sense, this person provides the creativity and the elbow work, and we'll split the profits." That can work out spectacularly well for the VC where they invest $X and get back 10 - 100 time $X in wealth. It doesn't always work out, but if it works out enough times, the VC can turn their money into more money faster that way than with say investing in government bonds.
In Silicon Valley this works because of two things, one there was a tradition of providing equity to employees which, when companies grew, put a lot of the wealth generated in the hands of individuals rather than companies. And secondly, California had some pretty good laws on the books about disallowing "non-compete" employment agreements so people who thought they could do the same thing their company was doing, only better, could go out and start a new company doing the same thing without too much risk of getting sued.
Having lived here I can tell you that 20 - 30 year old people are much more willing to invest in something risky than 50 - 60 year old people. So getting that wealth into younger hands adds to the risk tolerance.
To this point: Or maybe I am just poor and don’t get how people with large amounts of cash think. I expect it is a scale thing.
Imagine you have saved enough to pay for all your kids college education and you start your "retirement" fund. And you save money in that until the returns on that fund are actually enough to provide you with the same income, and in the US buy you the same medical coverage, you are currently experiencing working. Now you can "leave your job" and have a lot of free time. (It doesn't mean you can buy a yacht or an airplane and party all the time, just that you're new lifestyle looks like your old lifestyle with the single exception that you don't have to go into work every weekday). Now you end up with a few million $ more for this "third" account. What to do with that? Well a lot of people feel comfortable "gambling" some of that on new ventures because if they lose it, it won't change their life, and if they get a big winner, well it means more things they can try.
So to understand it, you have to imagine that you've got enough savings for all of the life expenses you expect to have going forward, and you have enough savings on top of that such that those savings are providing the equivalent to having a good job (pay and benefits), and now you have savings on top of that.
In the current batch, there are estimates of >100,000 former Google, Apple, Microsoft, and Facebook employees are in that position today. Money did a story on how the density of billionaires in San Francisco was the highest in the world [1] (post Crypto-crash I'm guessing this number went down :-)).
So why do young millionaires and billionaires invest in crazy ideas? Maybe because it is more exciting than having a few million dollars sitting in a bank account doing "nothing"?
I have a friend who retired somewhat early as CxO of a company with a (lowish 8 figure?) payday. Although, from a financial perspective he somewhat regretted spending about a decade doing a bunch of angel investing rather than just investing in big tech, I think it was also sort of a hobby and he still invests in a few companies he's particularly interested in. Along with also being involved in philanthropy with a large local institution.
So, yeah, there's a level where you know you don't have the money to routinely fly private or buy a super-yacht or buy properties around the world. But you have enough for any expenses you reasonably want/need and may not even want a bunch of the stuff that more money could buy. So you throw some money at interesting things.
a) Yes in some cases engineers with no business experience get funding. But in most cases there is significant due diligence being done on the capabilities of the team.
b) There is plenty of history that engineers with great product sensibilities can learn to run a business and become successfully by augmenting their weaknesses with members of the SLT who are stronger at them.
c) The whole point is for them to deploy their LPs money rather than just letting sit around waiting for the perfect idea/team/market etc combination to arrive on your lap. That simply doesn't happen.
I have recently started a course in corporate finance at my local uni because my new role requires me to understand accounting, making business decision and so on.
I haven’t finished my course, and I have to admit that I skimmed the article. So what I am about to say is probably wrong. It’s a feeling I have.
I have the feeling that a lot of theses articles are pretty basic corporate finance. What I mean is that if you study and try to understand basic CF, you will gain the insights that many of these articles talk about.
When I then read in the comments that there are cases where tech leads with no business experience get millions in funding and basically are learning by doing. Silicon Valley seems to be on another planet for me. It’s sounds surreal to me.
If I was an investor I would never give that person money since projects are so extremely difficult. The wicked problem is a real thing. Or maybe I am just poor and don’t get how people with large amounts of cash think. I get that it’s a numbers game and you have a portfolio of companies, but still.
Guys that are closer to SV, I would love to hear your thoughts on my thoughts.