If your conclusion is correct, how are the VCs staying in business?
http://www.avc.com/a_vc/2013/02/venture-capital-returns.html...
http://www.kauffman.org/newsroom/2012/07/institutional-limit...
Net, on average, the returns are poor.
> If your conclusion is correct, how are the VCs staying in business?
Reasons:
(1) The money comes from the limited partners (LPs), and they are heavily investors with big bucks. We're talking billions, from university endowments, state pension funds, sovereign wealth funds (say, a fund run by a rich Mideast oil country), some family wealth funds, maybe some insurance companies, maybe some hedge funds.
Of course, venture might hit a grand slam with great returns, and no doubt each venture firm that raises money from LPs claims that they are a top tier firm with great advantages and some great investment themes that with their "deep domain knowledge" and great business experience and insight will let them get much better than average returns.
These limited partners invest billions in all good looking asset classes. Venture capital is regarded by the LPs as an asset class but is relatively small. So, for the limited partners, venture capital is small potatoes and slips in under the wire even if on average the returns have been poor.
(2) The LPs have FMO -- fear of missing out. Due to the rapid progress of technology, the Internet, etc., the venture firms can keep telling the LPs that "This time it's different." with some possibility of being correct. So, some portfolio manager at an LP doesn't want to have to answer why they didn't invest in KPCB or Sequoia and, thus, missed out on Google.
(3) The LPs are not good at technology or able to evaluate "ideas" or look for "better" ideas. Instead, the LPs are closer to traditional commercial bank lending and private equity that put a lot of weight on accounting statements and don't expect to evaluate ideas or technology. So, the LPs are not pushing their venture firms to evaluate "ideas".
But, but, but, they plan to make it up on the volume!
I hope that is sarcasm: https://en.wikipedia.org/wiki/Groupon#Business_model
I suspect the real business model for most of these high-growth-without-a-plan-to-make-a-profit businesses is really eyeball exhaustion. The big players like google and facebook can monetize eyeballs, but they can only do this if they have people on their platforms. A loss making business can grab enough eyeballs that they will significantly affect the bottom line of the large players. The large players have to respond by buying up these startups and shutting them down.
As long as the VCs don’t back too many of these types of startups then it should be quite an effective way to shakedown the large players.
Rule 1: Find a startup with traction significantly large and growing rapidly in a huge market and where, still, the founders are very short on cash and will sign a term sheet with some really onerous conditions. E.g., the founders suddenly go from owning 100% to owning 0% and may get back to 60% on a four year vesting schedule. The BoD, dominated by the venture capital partners, can fire the founders before their stock is vested.
Rule 2: Claim a lot of items on a long list of what venture capital is about other than Rule 1. Claim it's about technology, innovation, brilliant founders, great leaders, changing the world, with the venture firm helping by using their long experience, "deep domain knowledge", etc.
Rule 2 is 100% noise, just misdirection, to keep people from noticing Rule 1.
Other major parts of our society are really good at innovation, creating it, evaluating it, exploiting it, etc., but not the venture capital firms. They won't evaluate innovations. Instead, again, they just follow the two rules.
As in the title, "better ideas"? The venture firms never consider the quality of the ideas -- instead, they just follow Rules 1 and 2. Or, on evaluating the ideas, they just let the market decide and then look at traction to see what the market has decided.
Sometimes they make a lot of money, but on average their returns are poor.