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welcome to money is freedom

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a podcast

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exploring how finance and freedom connect in our lives

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created from thoughtful research

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and narrated by Notebook LM AI

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this series brings you clear

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meaningful insights into finance and beyond

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episode 32 analyzes the challenges

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and low success rates in venture capital

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using y Combinator and Lightspeed Venture Partners

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as case studies data reveals that

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although some firms produce massive successes

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the vast majority of startups fail

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and even top tier firms experience

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low returns on many investments

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this is attributed to a power law

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distribution of returns high failure rates

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lengthy investment horizons and market volatility

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accompanying podcasts and blog posts

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discuss the related topic of fiscal dominance

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and its economic impact

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alright so today

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we're gonna be

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diving into the world of venture capital okay

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um and you know

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something that I know

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a lot of our listeners are really interested in yeah

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we're gonna be looking at an article called

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Venture Capital Is Harder Than You think

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here's the data to prove it

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uh huh and this is from Crypto Daily interesting

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it's easy to see you know

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all this hype around getting rich

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oh yeah backing the next big thing

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absolutely but

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we're gonna kind of pull back the curtain a little bit

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yeah on on VC really see what the truth is

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love it so

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the article starts off by kind of shattering this myth

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okay that VC is like a guaranteed path to riches right

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and it talks about this idea of the power law okay

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which basically says that

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you know a small handful of companies drive

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you know the lion's sheriff returns

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yeah it's kind of a winter take all situation

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exactly and that has major implications for how

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investors approach VC

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you wouldn't put all your eggs in one basket

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if you're building a portfolio right

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same principle here yeah

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diversification is key yeah

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but even then

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the power law suggests that most investments will yield

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minimal returns

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so even if you have a VC firm and they invest in

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let's say 100 companies yeah

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their success might just depend on one or two

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right becoming like the next Google or Amazon

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exactly and so the article uses y Combinator

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the y C as a case study interesting

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there are a very prestigious startup accelerator

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for sure that backed companies like Airbnb and stripe

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wow but what's really surprising is that only 4

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5% of those companies that y see backs

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actually reach that coveted unicorn status

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yeah which is

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you know valued over $1 billion

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wow that's a remarkably low percentage

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great

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especially considering YC's reputation for selecting

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promising startups exactly

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yeah and it gets even more interesting

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when you look at the successful exits okay

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like ipos or acquisitions

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only about 10% of YC companies achieve those milestones

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that means the vast majority

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don't reach those levels of success

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that investors typically hope for

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yeah that was pretty eye opening

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and the article goes on to say that just four companies

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yeah Airbnb Coinbase

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Reddit and instacart

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wow account for 85% of YC's total returns

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oh my gosh think about that for a second yeah

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out of all the innovative companies that YC has backed

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a mere four

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are responsible for the vast majority of their success

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yeah it really drives home that power law dynamic

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we were just talking about

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it makes you wonder like how do they

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how do these vcs navigate this landscape

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knowing that most of these investments won't yield

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a significant return absolutely

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it highlights the importance of due diligence

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yeah and rigorous evaluation right

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vcs need to be incredibly discerning

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yeah when choosing which companies to back yeah

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recognizing that even the most promising ventures

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face an uphill battle the article then shifts gears

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and talks about Light Speed

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Venture Partners okay

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which is another big player in the VC world right

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and especially in the AI space yeah

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they've backed companies like anthropic

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okay Mistral AI

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interesting open AI

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wow but what was really interesting was

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there was this table

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that showed their fund performance over time

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and it showed some really intriguing insights

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yeah about the volatility of VC returns okay

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so their older funds yeah

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the ones that were launched between 2006 and 2012

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performed exceptionally well okay

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generated really impressive DPI multiples

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now hold on

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for those of us who aren't fluent in VC jargon right

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can you break down what DPI means yes please

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and why it's important yeah

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DPI stands for distributions to paid in capital

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okay in simple terms

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uh huh it's your report card for AVC Fund

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I like that

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it tells you how much actual cash you're getting back

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yeah compared to what you initially invested

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a high DPI indicates strong returns

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right which is what every investor hopes for yeah

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so

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Lightspe's older funds were delivering impressive DPI

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meaning investors were seeing

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substantial returns on their investment right

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but then the article goes on to say okay

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that their more recent funds

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yeah from 2018 to 2022

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okay they're showing much lower DPI interesting

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so what's the reason for this shift

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well it's a reflection of

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the inherent unpredictability of venture capital

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uh huh even establish firms like light speed

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yeah with a proven track record

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right aren't immune to market fluctuations

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hmm

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their recent funds are showing slower liquidity events

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okay meaning it's taking longer

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yeah for investments to mature

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and generate cash returns through ipos or acquisitions

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so even if a fund is invested in promising companies

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yeah there's no guarantee

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of when those investments will actually turn into like

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tangible returns yeah

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for investors exactly

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it seems like patience is key in VC

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it seems like there's a lot more to VC

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yes than meets the

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I totally agree

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it's not just about throwing money at the next

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shiny startup right

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it's a complex ecosystem it is with its own rules

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yeah challenges

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the sure and rewards absolutely

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and it's fascinating how

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they talk about Lightspeed's AI

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investment strategy yeah

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they're clearly betting big on the future of AI

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but they also say you know

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this is still early days right

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a lot of these ventures could fizzle out

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absolutely

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unpredictable nature seems to be like a constant theme

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definitely it's like surfing

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you're riding the wave of innovation right

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but you never know when it might crash

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yeah

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even with all the data analysis and the due diligence

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yeah there's an element a chance involved

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the article lists a bunch of other things that make VC

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so tricky yeah

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it's not just market volatility right

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things like long investment horizons

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the difficulty of getting your money out

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should we maybe unpack those a bit more

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absolutely let's unpack those

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okay first you got the long investment horizon

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yeah we touched on this a little earlier

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yeah but it's worth emphasizing

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VC isn't like buying a stock

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and hoping it goes up next week right

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this is about planting seeds that might take years

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yeah maybe even a decade to bear fruit

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which must be tough

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for both investors and entrepreneurs

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absolutely the investors have to be patient

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yeah and the entrepreneurs have to keep pushing forward

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even when the pay off is so far down the road

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exactly and then there's the issue of liquidity

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or rather the lack of it okay

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you might see a fund with a great tvpi

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meaning

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the total value of their investments looks fantastic

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okay on paper right

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but that doesn't mean investors can easily cash out

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another acronym alert tvpi

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okay break that one down for me

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think of tvpi is the total value to Pating Capital okay

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basically a snapshot yeah

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of the current value of the fund's holdings

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but here's the catch okay

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it doesn't reflect the actual cash

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yeah that investors can access

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so tvpi might look promising yeah

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but until those investments are actually sold right

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whether through an IPO or acquisition

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hmm investors are essentially holding ill liquid assets

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yeah precisely

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it's like owning a beautiful house yeah

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okay you could appreciate its value yeah

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but you can't easily spend that value right

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until you actually sell it

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so patience and understanding the long game are crucial

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absolutely for VC investors yeah

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what about some of those other challenges

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the article lists well

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we talked about the power law

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distribution and the high failure rate

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but beyond that yeah

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you've got marketcyclicality

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tech downturns AI hype cycles

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yeah even broader economic conditions right

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all of these can impact valuations yeah

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they make exits harder it's like navigating a ship

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okay through unpredictable waters

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it makes you realize how external forces

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can really impact a startup's fate

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absolutely no matter how brilliant the idea or team is

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exactly and then

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there's the risk associated with Fallawon Capital yep

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even those startups

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that manage to secure that initial funding right

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often struggle to raise subsequent rounds as they grow

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yeah you know

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Series a Series B

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and so on yeah

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those hurdles can be incredibly tough to clear

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you know it's interesting

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because they talk about

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not just the numbers in the data

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but they also talk about like right

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the psychological factors at play

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absolutely they talk about this optimism bias

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yeah where both entrepreneurs

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and investors

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tend to overestimate their chances of success

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hmm what are your thoughts on that

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I think it's a fascinating aspect of the VC world okay

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there's a certain allure yeah

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a sense of possibility right

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that draws people in

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entrepreneurs

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dream of building the next billion dollar company

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yeah and investors are enticed by that potential

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for massive returns

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but the reality is

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most startups don't achieve those lofty goals

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it's like that old lottery saying

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you can't win if you don't play

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but in the case of VC yeah

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the odds of hitting the Jackpot are incredibly slim

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exactly

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and that's where the importance of due diligence

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comes in right

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for investors yeah

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it's about conducting thorough research

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looking beyond the hype yeah

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really understanding the fundamentals of the business

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okay are they solving a real problem right

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do they have a sustainable business model

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what's their competitive landscape like

278
00:10:24,333 --> 00:10:25,166
it seems like

279
00:10:25,166 --> 00:10:28,266
separating the signal from the noise is crucial

280
00:10:29,533 --> 00:10:30,966
in a field like this yeah

281
00:10:30,966 --> 00:10:34,300
especially in a fast moving area like AI

282
00:10:34,300 --> 00:10:36,666
right where there's so much hype and buzz

283
00:10:36,766 --> 00:10:39,666
investors need to be able to critically evaluate

284
00:10:40,000 --> 00:10:42,100
those claims and projections yeah

285
00:10:42,100 --> 00:10:44,533
understanding that early stage companies right

286
00:10:44,533 --> 00:10:46,966
often operate with limited data

287
00:10:47,666 --> 00:10:49,400
and high degree of uncertainty yeah

288
00:10:49,400 --> 00:10:50,733
what about for entrepreneurs

289
00:10:50,733 --> 00:10:53,166
yeah what role does do diligence play for them

290
00:10:53,166 --> 00:10:55,100
for entrepreneurs yeah

291
00:10:55,166 --> 00:10:58,866
due diligence means understanding the VC landscape

292
00:10:59,200 --> 00:11:02,100
knowing which firms invest in their industry

293
00:11:02,333 --> 00:11:04,166
what stage of development they focus on

294
00:11:04,166 --> 00:11:06,133
right and what their investment philosophy is

295
00:11:06,133 --> 00:11:08,333
so it's not just about finding money right

296
00:11:08,333 --> 00:11:09,933
it's about finding the right partners

297
00:11:09,933 --> 00:11:11,666
exactly okay

298
00:11:11,666 --> 00:11:13,933
and it also involves being prepared

299
00:11:13,933 --> 00:11:17,266
yeah to answer tough questions about your business okay

300
00:11:17,266 --> 00:11:19,400
investors wanna see yeah

301
00:11:19,400 --> 00:11:21,133
a solid teen uh huh

302
00:11:21,133 --> 00:11:23,066
a compelling vision right

303
00:11:23,066 --> 00:11:25,300
and a clear path to profitability

304
00:11:25,300 --> 00:11:26,766
it's about building trust

305
00:11:26,766 --> 00:11:29,500
yeah and demonstrating that you're not just

306
00:11:29,533 --> 00:11:31,766
chasing the next round of funding right

307
00:11:31,766 --> 00:11:33,933
but you're building a sustainable business

308
00:11:33,933 --> 00:11:35,800
exactly for the long haul

309
00:11:35,800 --> 00:11:36,700
and remember yeah

310
00:11:36,700 --> 00:11:40,000
investors are betting on people as much as ideas right

311
00:11:40,000 --> 00:11:41,866
they wanna see passion mmm hmm

312
00:11:41,866 --> 00:11:45,700
expertise and a willingness to learn and adapt

313
00:11:45,966 --> 00:11:46,733
which makes sense

314
00:11:46,733 --> 00:11:48,666
given all the challenges that we've talked about

315
00:11:48,666 --> 00:11:49,933
market volatility yeah

316
00:11:49,933 --> 00:11:53,000
long investment horizons absolutely intense competent

317
00:11:53,000 --> 00:11:55,300
right it takes a special kind of resilience

318
00:11:55,300 --> 00:11:58,266
it does to navigate the world of VC for sure

319
00:11:58,266 --> 00:12:00,766
it sounds like to really make it in VC

320
00:12:00,766 --> 00:12:02,366
you need vision and determination

321
00:12:02,366 --> 00:12:03,000
oh yeah

322
00:12:03,000 --> 00:12:05,400
and a pre thick skin for sure

323
00:12:05,400 --> 00:12:07,800
but even with all the right qualities

324
00:12:08,000 --> 00:12:12,300
this article emphasizes that timing plays a huge role

325
00:12:12,333 --> 00:12:13,733
it does so we've talked about

326
00:12:13,733 --> 00:12:15,466
you know it's a long game right

327
00:12:15,466 --> 00:12:19,533
but recognizing that VC operates in cycles exactly

328
00:12:19,533 --> 00:12:22,100
there's these periods of exuberance yeah

329
00:12:22,100 --> 00:12:24,400
like what we're seeing now with AI yeah

330
00:12:24,400 --> 00:12:26,166
followed by these periods of correction

331
00:12:26,166 --> 00:12:27,666
and reevaluation for sure

332
00:12:27,666 --> 00:12:29,533
so even if you have a great company

333
00:12:29,533 --> 00:12:31,933
yeah hitting the market at the wrong time

334
00:12:31,933 --> 00:12:35,066
uh huh could make all the difference absolutely yeah

335
00:12:35,066 --> 00:12:37,133
it underscores the need yeah

336
00:12:37,133 --> 00:12:39,266
for both investors and entrepreneurs

337
00:12:39,266 --> 00:12:40,500
right to be realistic

338
00:12:40,500 --> 00:12:42,833
uh huh and not get swept up in the hype right

339
00:12:43,000 --> 00:12:46,166
a solid business idea with strong fundamentals

340
00:12:46,166 --> 00:12:48,000
yeah will weather those cycles

341
00:12:48,000 --> 00:12:50,066
better than one built on hype alone

342
00:12:50,066 --> 00:12:53,600
it all ties back to this idea of follow on capital risk

343
00:12:53,600 --> 00:12:54,500
the article says

344
00:12:54,500 --> 00:12:58,166
even startups that secure initial funding right

345
00:12:58,166 --> 00:13:00,933
often struggle to raise those subsequent rounds

346
00:13:00,933 --> 00:13:02,333
as they grow uh huh

347
00:13:02,333 --> 00:13:04,266
why is that such a critical hurdle

348
00:13:04,266 --> 00:13:07,200
well imagine a startup is like a rocket ship okay

349
00:13:07,200 --> 00:13:08,966
the initial funding gets it off the ground

350
00:13:08,966 --> 00:13:11,333
uh huh but reaching orbit yeah

351
00:13:11,333 --> 00:13:13,466
requires multiple stages uh huh

352
00:13:13,566 --> 00:13:16,300
with increasingly powerful engines exactly

353
00:13:16,300 --> 00:13:18,466
each follow on funding round

354
00:13:18,466 --> 00:13:19,733
Series a Series B

355
00:13:19,733 --> 00:13:20,866
and so on right

356
00:13:20,866 --> 00:13:23,900
represents a critical stage in that journey absolutely

357
00:13:23,900 --> 00:13:26,433
so it's not just about getting that first check

358
00:13:26,666 --> 00:13:28,700
it's about maintaining that momentum

359
00:13:28,700 --> 00:13:31,166
yes and convincing investors right

360
00:13:31,166 --> 00:13:33,300
that the company is on a trajectory towards

361
00:13:33,300 --> 00:13:35,066
substantial growth exactly

362
00:13:35,066 --> 00:13:36,600
and eventual probability

363
00:13:36,600 --> 00:13:38,366
the stakes get higher with each round

364
00:13:38,366 --> 00:13:39,366
yeah later stage

365
00:13:39,366 --> 00:13:40,966
investors are looking for more

366
00:13:41,300 --> 00:13:43,166
then just a promising idea right

367
00:13:43,166 --> 00:13:45,700
they want to see results proof of traction

368
00:13:45,700 --> 00:13:47,066
okay revenue growth

369
00:13:47,066 --> 00:13:49,900
right and a clear path to market dominance

370
00:13:49,900 --> 00:13:50,100
so

371
00:13:50,100 --> 00:13:52,866
it sounds like a constant pressure cooker for startups

372
00:13:52,866 --> 00:13:55,600
they're not just building a product or a service

373
00:13:56,733 --> 00:13:59,566
but they're constantly having to prove their worth

374
00:13:59,866 --> 00:14:01,266
to potential investors

375
00:14:01,266 --> 00:14:03,533
that's the reality of the VC game yeah

376
00:14:03,533 --> 00:14:05,900
it's a highly competitive environment

377
00:14:05,900 --> 00:14:07,933
right where only the strongest

378
00:14:07,933 --> 00:14:11,133
right and most adaptable survive for sure

379
00:14:11,133 --> 00:14:13,633
and that's why for entrepreneurs yeah

380
00:14:14,300 --> 00:14:16,700
focusing on building that strong foundation

381
00:14:17,100 --> 00:14:19,933
is Paramount what does that look like in practice

382
00:14:19,933 --> 00:14:22,300
it starts with solving a real problem

383
00:14:22,300 --> 00:14:24,066
okay for a defined market

384
00:14:24,066 --> 00:14:24,600
yeah

385
00:14:24,600 --> 00:14:27,366
building a product or service that people actually need

386
00:14:27,366 --> 00:14:29,566
right and are willing to pay for right

387
00:14:29,566 --> 00:14:29,866
then

388
00:14:29,866 --> 00:14:32,666
it's about assembling a talented and dedicated team

389
00:14:32,666 --> 00:14:34,800
yeah people who share the vision

390
00:14:34,900 --> 00:14:36,566
and are in it for the long haul right

391
00:14:36,566 --> 00:14:37,133
and finally

392
00:14:37,133 --> 00:14:40,100
it's about developing a sustainable business model okay

393
00:14:40,100 --> 00:14:42,133
one that can generate revenue right

394
00:14:42,133 --> 00:14:43,766
managed costs yeah

395
00:14:43,766 --> 00:14:45,233
and ultimately turn a profit

396
00:14:45,300 --> 00:14:47,100
so it's about focusing on the fundamentals

397
00:14:47,100 --> 00:14:49,766
it is not getting distracted by short term trends

398
00:14:49,766 --> 00:14:52,400
or trying to be the next overnight sensation

399
00:14:52,400 --> 00:14:54,133
and being adaptable yeah

400
00:14:54,133 --> 00:14:55,100
and resourceful

401
00:14:55,366 --> 00:14:58,900
the start up journey is rarely a straight line okay

402
00:14:58,900 --> 00:15:00,533
there will be setbacks mm hmm

403
00:15:00,533 --> 00:15:02,466
unexpected challenges right

404
00:15:02,466 --> 00:15:04,966
moments where you have to pivot and adjust course

405
00:15:05,066 --> 00:15:07,900
this deep dive has been really eye opening for me

406
00:15:07,900 --> 00:15:09,100
I'm glad you know

407
00:15:09,100 --> 00:15:11,366
going behind the curtain of the VC world

408
00:15:11,366 --> 00:15:13,766
and all complexities and nuances

409
00:15:13,766 --> 00:15:14,300
for sure

410
00:15:14,300 --> 00:15:17,600
it's clear that VC is not for the faint of heart

411
00:15:17,600 --> 00:15:19,000
I think that's a fair assessment

412
00:15:19,000 --> 00:15:20,700
yeah it's a high stakes

413
00:15:20,933 --> 00:15:24,100
high reward environment that demands

414
00:15:24,800 --> 00:15:27,100
you know a really unique blend yeah

415
00:15:27,100 --> 00:15:28,600
a vision resilience

416
00:15:28,700 --> 00:15:30,600
and a deep understanding of the game

417
00:15:30,600 --> 00:15:32,000
so for anyone listening

418
00:15:32,000 --> 00:15:34,300
who's thinking about entering this world

419
00:15:34,300 --> 00:15:37,233
yeah whether as an entrepreneur or an investor

420
00:15:37,666 --> 00:15:39,533
what advice would you leave them with

421
00:15:39,533 --> 00:15:42,700
I would say go in with your eyes wide open okay

422
00:15:42,700 --> 00:15:45,000
understand the risks challenges

423
00:15:45,000 --> 00:15:46,466
the sheer amount of work involved

424
00:15:46,466 --> 00:15:49,466
yeah but also embrace the potential

425
00:15:49,466 --> 00:15:50,933
the excitement of innovation

426
00:15:50,933 --> 00:15:53,966
yeah and the possibility of contributing to something

427
00:15:53,966 --> 00:15:57,533
truly groundbreaking that's a great note to end on

428
00:15:57,533 --> 00:15:58,366
thanks you know

429
00:15:58,366 --> 00:15:59,900
being realistic yeah

430
00:15:59,900 --> 00:16:03,300
but not losing sight of that passion and that dream

431
00:16:03,300 --> 00:16:06,700
right that drives the entrepreneurial spirit absolutely

432
00:16:06,700 --> 00:16:07,800
thanks for joining us today

433
00:16:07,800 --> 00:16:10,466
on this deep dive into the world of venture capital

434
00:16:10,466 --> 00:16:11,566
my pleasure