essays and pithy thoughts

Venture Capital: meeeeeeh.

in glhf

From a comment on this blog, vintage January 2011 (emphasis mine):

Ive seen one too many articles like this coming from PC gamers who have spew cynicism after the fall of CPL and CGS. There is a lot you didn’t get right in your article, and it’s good that Sundance took the time to chat with you. There are a lot of people working on this, and we NEED VC. You may think it means things are unhealthy, but VCers don’t just throw money away.

Heh, funny thing…turns out they do! Every day! It’s part of their model, one that is showing signs of unraveling.

A closer look at VC firms and returns since the advent of their model has been making the rounds in econ blogs this past month, and is now bubbling up to some more widely viewed publications. The verdict?

Meeeeeh. Double meeeeh.

The very nature of VC is to wade out in high risk/high reward waters. That MLG has been able to court so much VC to this point is not a sign of a sure thing or of stability; VC is a longshot bet that could pay off quite large if things all work out as planned. Thus, in a general sense, VC firms aren’t looking for 50/50 bets, where there’s moderate risk and moderate reward. They’re looking for stuff in a sort of goldilocks region between a coin flip and downright impossible, where the risk is nauseating like airplane turbulence, but the payout will be large if it hits.

VC firms load up on these sorts of bets in a bid for solvency. The theory goes that if a VC firm takes a large amount of capital and hedges their bets across many such longshots, the ones that do pay out will more than offset the ones that blow up.

As it turns out, only the upper crust of VC firms are able to make good on this theory and outpace the market at large. Also, the dot-com bubble popping in 2000 is a definitive fault line in the data; VC as a whole outperformed the market (S&P 500) on average by about two and a half times before 2000, and has actually been worse since.

Felix Salmon of Reuters:

If you look at the performance of VC funds during the golden years of 1986-1999, it turns out that once you strip out the top-performing 29 funds, the rest — more than 500 — collectively invested $160 billion, and managed to return $85 billion to investors. If you can’t get into one of the best funds — and everybody knows which funds those are — then there’s really no point investing in venture capital at all. But what happens is that some investment board looks at VC returns inclusive of the best funds’ returns, and then mandates a certain investment in VC which assumes they’ll have some kind of access to those top-tier funds. And that’s an extremely dangerous assumption to make, because most of the time it won’t be true.

It means there’s a particular class of VC funds that do just fine, and have the right sense about finding the right kind of bets. A few select firms are making considerable money for their clients. The rest are absolute rubbish, losing half the money they invest, on average; sometimes better, sometimes worse, but still shit.

Things appeared to be kicking along quite well pre-dot-com because the number of bad firms didn’t outnumber the good ones so handily. As the demand for these sorts of investments grew, that basically looked so good because of the tech bubble, the proportions went significantly in the other direction as people piled on the bandwagon.

All this does not say anything definitive about the VC that is in esports today, up or down. All this data was provided on an anonymous basis, so there’s no way to trace it back to specific firms. It’s about the odds, from a wide perspective, that the right type of firms saw the right stuff in a bet on esports. However you may slice it, there are significant odds that at some point in the future, we’ll be talking about this nacent era as a VC-fueled mirage. Those are simply the numbers.