Why many people fail to understand the business of Venture Capital
I have seen a lot of experienced and inexperienced people in different fields of professions who are fierce critics of the Venture Capital industry. (I would like to point out that you’ll find a hell lot of them in India, where a lot of these critics believe that “we are in a Venture Capital/Startup bubble”)
A set of these critics provide some arguments in their favor and I’ve expressed my views about them:
- The critics say that the company has no “fundamental” backing: Most of these critics are the “self-centered” ones. “My way or the highway” types. They believe that there is only one single way of defining “good fundamentals”. That there is only one single way of defining “Value of a Company” and that way is their way. These people are often fans of the specific image of “Warren Buffet” that exists in their head. Note, they aren’t fans of Buffet, they are fans of the “perception of Buffet which they have in their heads”. Tell these people that Buffet sells out of the money puts and they freak out. Please understand: There are multiple people having multiple ways of defining “value”. Some look at the Debt:Equity while the others look purely from a Soros’s view of Reflexivity and “Perceptive Value”. It is naive when you hear someone ranting about how VCs have been allocating money to companies with the “wrong” fundamentals. TL;DR: Your way of computing “value” maybe different from the VC’s way, just learn to live with that and don’t get over-passionate with your way. Never marry your opinion. Infact, have an extra-marital affair with the counterparty’s view.
- The critics say that: the way the money is injected into startups, by the VCs is absolutely ridiculous. They lose 99% of the times! : Someone who says this is seriously inexperienced. There are multiple ways of investing money in a business: You can either chose to take a directional bet with a significant downside and upside, or you can actually buy a giant portfolio of cheap low probability events. Both techniques work fine. The VC’s opt for the second way. Simple. Why make it so complex? Professional investors exist on both sides and they don’t argue with each other. They live and let live and they make their money and get the hell out. Infact there are a class of professionals who actually specialize in the second kind of investing. They believe that the markets for companies are irrational and susceptible to low probability events which can actually wipe them out (for example the 2008 financial crisis). They like to keep their downside to minimum and upside unlimited by actually trading off the probability of profit and instead betting on the speculative expectation value of profit. Fund managers who go long on volatility and buy options are a living example of the second type of investors. VC’s roughly fall into the class of second type of investors. Similarly, there are great investors in the first category too.
“It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.”
~ George Soros