There are no (absolute) red flags in venture capital(blog.aaronkharris.com)
blog.aaronkharris.com
There are no (absolute) red flags in venture capital
https://blog.aaronkharris.com/there-are-no-absolute-red-flags-in-venture-capital
69 comments
If you look hard enough, there is always someone disagreeing/yelling fraud/etc about every topic that is big enough/mainstream enough.
It's only hindsight that shows whether your research showed something was obviously fraud.
It's only hindsight that shows whether your research showed something was obviously fraud.
Do you have any examples to back up your claim? Because I already debunked the examples the author gave.
there’s always somebody yelling fraud
look at herbal life as an example
or amway
look at herbal life as an example
or amway
Aren't those clearly frauds for the people participating, but as businesses they're just somehow structured in a way to be sound investments for those on the outside?
They are, and that's the joke.
Sadly, real people say stuff like that seriously. Without anything else to go on it would be unwise to assume the authors beliefs. /s is a helpful way to show that one is being sarcastic and not a serious ignoramus during online discussions that lack other communication channels like body language or inflection.
I agree. At least 1 person in this thread got it wrong and it could have been me.
If those were frauds, there would be ton of lawsuits by now given their history.
It may or may not be immoral for participants, but illegality is a much higher bar.
It may or may not be immoral for participants, but illegality is a much higher bar.
I mean, they might just be a class of frauds that are currently legal thanks to lack of will to close a particular loophole that permits their existence. And it's not as if they don't receive legal penalties all the time:
https://heavy.com/news/2020/08/herbalife/
https://www.cs.cmu.edu/~dst/Amway/AUS/hanrahan.htm
https://heavy.com/news/2020/08/herbalife/
https://www.cs.cmu.edu/~dst/Amway/AUS/hanrahan.htm
There were. Lots of them.
So much so that both Herbalife and Amway have been under numerous consent decrees with the US government for decades [1][2].
[1] https://www.ftc.gov/news-events/news/press-releases/2016/07/...
[2] https://www.govinfo.gov/content/pkg/FR-1994-03-23/html/94-67...
So much so that both Herbalife and Amway have been under numerous consent decrees with the US government for decades [1][2].
[1] https://www.ftc.gov/news-events/news/press-releases/2016/07/...
[2] https://www.govinfo.gov/content/pkg/FR-1994-03-23/html/94-67...
This sub-thread is very amusing. All you people saying if it was fraud there would be lawsuits. Guess what, there are tons of lawsuits against these companies and also settlements. And vc doesn't care! Look at the genius. Look at WeWork and Adam Neumann. Many people saw it was impossible to make money and meet their valuation.
This and small time fraud does not even make it to a police report..
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yeah but nowadays everyone is constantly calling everyone out, everything is a shitcoin if it's not your favorite thing, etc, so too much noise in that
Harry Markopolos was calling out Madoff for nearly a decade, with accounting-based evidence on why it was impossible and an incredibly simple way to verify if Madoff was lying for the SEC or the DTCC. The SEC never bothered to check if he was lying about his trades (or simply decided to keep it quiet), the kind of thing that would likely take them minutes to find out.
It's really more like Hindenburg Research and Adani. Hindenburg Research is just better at making a splash. But the evidence was always damning.
It's really more like Hindenburg Research and Adani. Hindenburg Research is just better at making a splash. But the evidence was always damning.
Or... a completely brand new market with billions of dollars sloshing around, varying between completely unregulated and effectively unregulated, is actually rife with actual fraud.
I'm not saying there's no fraud, I'm saying people being unofficially "called out" doesn't mean much
The biggest red flag is that both VCs and founders are required to be highly irrational at their core.
Founders are gamblers, betting they will be the one to win against the odds. Most companies fail, and the expected returns are approximately zero, with all the average returns coming from few winners. Founders that take VC money are multiplying their risk by giving away preferential shares (founder gets approximately zero if business is just mildly successful), founder radically increasing the pressure upon themselves, and if you need VC money you are usually by definition in a highly competitive market where growth-rate wins the market.
VCs are irrational because the vast majority of VC funds fail to beat the market. Fund managers do OK from their 2% fees, but a majority of VCs will not make excessive money (while some minority do make a lot). https://techcrunch.com/2017/06/01/the-meeting-that-showed-me... references slide 14[2] that shows 2% of VC funds (the top 20) rake in 95% of market returns: VC fund returns are nearly as skewed power law as founder returns are!
Power laws of returns truely suck for the majority. Think iPhone games.
[2] https://www.slideshare.net/gilbenartzy/money-talks-things-yo...
Founders are gamblers, betting they will be the one to win against the odds. Most companies fail, and the expected returns are approximately zero, with all the average returns coming from few winners. Founders that take VC money are multiplying their risk by giving away preferential shares (founder gets approximately zero if business is just mildly successful), founder radically increasing the pressure upon themselves, and if you need VC money you are usually by definition in a highly competitive market where growth-rate wins the market.
VCs are irrational because the vast majority of VC funds fail to beat the market. Fund managers do OK from their 2% fees, but a majority of VCs will not make excessive money (while some minority do make a lot). https://techcrunch.com/2017/06/01/the-meeting-that-showed-me... references slide 14[2] that shows 2% of VC funds (the top 20) rake in 95% of market returns: VC fund returns are nearly as skewed power law as founder returns are!
Power laws of returns truely suck for the majority. Think iPhone games.
[2] https://www.slideshare.net/gilbenartzy/money-talks-things-yo...
This essay becomes more fun -- and more useful -- if we apply OP's standards to other areas of trust and risk. For example:
- Are there no absolute red flags in online dating? (Some ex-convicts with teardrop tattoos may be fully reformed.)
- Are there no absolute red flags in getting into a taxi (Some angry drivers with alcohol on their breath may be capable of getting to the destination.)
In such situations, the thought experiment fails. Wrong decisions can be catastrophic or fatal. Past a certain point, we don't roll the dice, even if good outcomes are possible, too. And we cringe when others knowingly take those risks.
OP's argument probably works best for Y Combinator, where the financial risk per deal is small and fully bounded. (The portfolio is vast; there's no implicit commitment to fund any deal beyond $500k, and everything is so early stage that the worst investments will likely fail quietly. They won't become the reputation-ruining messes of expose journalism, indictments, etc. that will impair your ability to stay in the venture business.)
For larger VC firms, particularly ones that get most of their capital from scandal-wary limited partners at universities or state retirement orgs, it's a different story. Extreme investment outcomes (good or bad) define your reputation in ways that can last for many years. Even a single deal's red-flag implosion can hurt your credibility far longer than you'd like.
So, bravo to OP for working at a firm where periodic red flags can be safely ignored. Do be careful in your choice of taxi drivers or online dates.
- Are there no absolute red flags in online dating? (Some ex-convicts with teardrop tattoos may be fully reformed.)
- Are there no absolute red flags in getting into a taxi (Some angry drivers with alcohol on their breath may be capable of getting to the destination.)
In such situations, the thought experiment fails. Wrong decisions can be catastrophic or fatal. Past a certain point, we don't roll the dice, even if good outcomes are possible, too. And we cringe when others knowingly take those risks.
OP's argument probably works best for Y Combinator, where the financial risk per deal is small and fully bounded. (The portfolio is vast; there's no implicit commitment to fund any deal beyond $500k, and everything is so early stage that the worst investments will likely fail quietly. They won't become the reputation-ruining messes of expose journalism, indictments, etc. that will impair your ability to stay in the venture business.)
For larger VC firms, particularly ones that get most of their capital from scandal-wary limited partners at universities or state retirement orgs, it's a different story. Extreme investment outcomes (good or bad) define your reputation in ways that can last for many years. Even a single deal's red-flag implosion can hurt your credibility far longer than you'd like.
So, bravo to OP for working at a firm where periodic red flags can be safely ignored. Do be careful in your choice of taxi drivers or online dates.
The difference is that you only have one life, which you are risking in the examples, whereas VCs have many dollars, of which they only risk a part on each trade.
Right, most of the risks incurred by corporations are socialized, due to various limitations on financial and criminal liability granted to shareholders, officers and managers.
Plus VCs are typically risking other people's money, not their own.
Well yes, the facts that the support structure for the proposed bridge would be mostly made of rusty scrap metal and zip ties and that the engineering team consists solely of Bob who has watched a YouTube video on bridge building once (but has a very good memory) absolutely do constitute red flags.
However, for an investor, a red flag is first and foremost just a piece of information. To make use of it, he must put it into a proper, objective context: Such as that we readily accept bridges made out of wood and ropes on our playgrounds - or that model railroad enthusiasts successfully used cardboard as a bridge-building material for decades.
Then the information must be weighed against expected rewards and mitigating factors, like the expected toll revenue before collapse or the fact that the location is close to the Mexican border, so everyone affected can quickly leave the country, should the need arise.
Only after carefully weighting all those pieces of information can an investor make an informed decision.
However, for an investor, a red flag is first and foremost just a piece of information. To make use of it, he must put it into a proper, objective context: Such as that we readily accept bridges made out of wood and ropes on our playgrounds - or that model railroad enthusiasts successfully used cardboard as a bridge-building material for decades.
Then the information must be weighed against expected rewards and mitigating factors, like the expected toll revenue before collapse or the fact that the location is close to the Mexican border, so everyone affected can quickly leave the country, should the need arise.
Only after carefully weighting all those pieces of information can an investor make an informed decision.
The red flag in Bobs project doesn't mean you can't make money out of an investment in this project.
Bob has secured ownership of the section of river and a contract with the local town to pay bob 100k when he connects the two sides of the river together. He just needs an investment of $1,000 in exchange for 10% of his company - (to buy the zip ties) - so he can get started with construction.
Looks like at least a 10 bagger, the investment committee is going to absolutely love Bob - I LOVE THIS FOUNDER! 10 out of 10! Might even be able to make more if Bob doesnt make it to the other side of the river and you can sell him off in an acqui-hire to someone looking for their very own Bob.
Bob has secured ownership of the section of river and a contract with the local town to pay bob 100k when he connects the two sides of the river together. He just needs an investment of $1,000 in exchange for 10% of his company - (to buy the zip ties) - so he can get started with construction.
Looks like at least a 10 bagger, the investment committee is going to absolutely love Bob - I LOVE THIS FOUNDER! 10 out of 10! Might even be able to make more if Bob doesnt make it to the other side of the river and you can sell him off in an acqui-hire to someone looking for their very own Bob.
There are some valuable points in there, but the "if the product is selling and the company is making money, how much of a problem could it be" in an article which references FTX and could have referenced Theranos sounds like Gordon Gecko style parody of the industry...
“ No sane person is going to invest in a scheme to turn lead into gold, but early-stage startups—and even some mid- and late-stage startups—rarely present such a clear-cut profile”
Why not? If the founder is sufficiently charismatic, huge followers and lots of suckers willing to pile in. Sure the odds of a real product are zero but odds of a 100x exit are non zero. It may be a decent enough investment dispite being outright fraud. If you think you are in early enough in the scam and you can get out.
Why not? If the founder is sufficiently charismatic, huge followers and lots of suckers willing to pile in. Sure the odds of a real product are zero but odds of a 100x exit are non zero. It may be a decent enough investment dispite being outright fraud. If you think you are in early enough in the scam and you can get out.
You may well have to give that money back however (eg, early investors with Madoff had to compensate later investors decades later).
Maybe, but failing to turn lead into food isn’t technically fraud. It’s just an inability to mature the technology into a viable long term product. Happens all the time with crypto, jucero etc. Movie pass was probably too close to Fraud though and risked clawback
This is a great example of what I think of as the "thought leader" style of Hackernews blog posts in which someone says something extremely obvious and at great length while taking pains to make it seems like its deep and insightful, even slyly subversive.
What does this post really say beyond "gee, there sure are a lot of different ways to think about investment in a company?"
What does this post really say beyond "gee, there sure are a lot of different ways to think about investment in a company?"
The red flag inherent to venture capital is venture capital.
Society recently felt government accountable to the range and gradient of human conditions was immoral so it changed the rules to let private power pick and choose and private power is pricing everyone out of homes and food, which is apparently quite moral.
Nevermind the state of reality we leave behind for the future; we’ll be dead. Those old religious metaphors about hell on Earth must be made so! Buy cars! Fly! We were promised this! Again the epitome of moral behavior.
Humans fairy tales run the world.
Society recently felt government accountable to the range and gradient of human conditions was immoral so it changed the rules to let private power pick and choose and private power is pricing everyone out of homes and food, which is apparently quite moral.
Nevermind the state of reality we leave behind for the future; we’ll be dead. Those old religious metaphors about hell on Earth must be made so! Buy cars! Fly! We were promised this! Again the epitome of moral behavior.
Humans fairy tales run the world.
>private power is pricing everyone out of homes
Last time I checked it was the government preventing me from building more dense housing as well as requiring parking minimums.
Last time I checked it was the government preventing me from building more dense housing as well as requiring parking minimums.
It's not so black and white. It's both. Local governments are the gatekeepers but they allow outside interests with sufficient power to rewrite their zoning laws.
A local twp near me as expressed in their meeting minutes let's outside interests redline and rewrite their zoning laws, given enough capital and sway. It's very specific to the municipality, the mechanisms and processes they have in law to change the current ones, and the local base it is comprised of.
A local twp near me as expressed in their meeting minutes let's outside interests redline and rewrite their zoning laws, given enough capital and sway. It's very specific to the municipality, the mechanisms and processes they have in law to change the current ones, and the local base it is comprised of.
Anyone with money and persistence can get variances in the local government. Try to be a regular person and get things done--you'll rapidly end up giving up.
> Last time I checked it was the government preventing me from building more dense housing
Mega-corp didnt have problems with getting approval (and a healthy cash grant to build it) for the exact same application. I wonder what they did differently?
Mega-corp didnt have problems with getting approval (and a healthy cash grant to build it) for the exact same application. I wonder what they did differently?
Simple: they actually benefit from the status quo. If only a very limited land supply is available for densification (say like maybe 5% of the city) then that land supply is fairly easy for a few players to corner.
And they "left" a Cadillac with $200,000 cash in the boot on the driveway of the person making the planning decisions.
[deleted]
Not exactly disagreement but venture capital funded colonialism and slavery; the ”recent” incarnation of corporatist/scale at all costs SV VC may be just an extension.
> Society recently felt government accountable to the range and gradient of human conditions was immoral so it changed the rules
The US did. That mentality is not present in the rest of the world.
The US did. That mentality is not present in the rest of the world.
> pricing everyone out of homes and food
The food part couldn’t be more wrong:
https://www.ers.usda.gov/amber-waves/2020/november/average-s...
The food part couldn’t be more wrong:
https://www.ers.usda.gov/amber-waves/2020/november/average-s...
This is an article from three years ago lol.
I see bottled water being sold for $6 for a 12 pack when it used to be $2 for a 24. Convince me that isn't price gouging. It's literally plastic and water.
I see bottled water being sold for $6 for a 12 pack when it used to be $2 for a 24. Convince me that isn't price gouging. It's literally plastic and water.
> Convince me that isn't price gouging. It's literally plastic and water.
Not that I fundamentally disagree, but your example is probably not a great one.
First is that fuel costs were abnormally high for several months and water in plastic bottles isn't exactly cheap to transport.
Second is that plastic is sourced from oil and guess what? It's been quite expensive until the recent leveling off.
Third is that as some regions of the US start to run out of ground water due to unusually long drought conditions, the availability of local water sources also dries up and thus requires buying more expensive sources of water or bringing that water in from further away.
Not that I fundamentally disagree, but your example is probably not a great one.
First is that fuel costs were abnormally high for several months and water in plastic bottles isn't exactly cheap to transport.
Second is that plastic is sourced from oil and guess what? It's been quite expensive until the recent leveling off.
Third is that as some regions of the US start to run out of ground water due to unusually long drought conditions, the availability of local water sources also dries up and thus requires buying more expensive sources of water or bringing that water in from further away.
These issues affect everything a grocery store sells. Crops are water dependent, food is heavy and bulky to transport, and it's all wrapped in plastic.
Previously the food industry competed on price. Supply was disrupted which any econ student would tell you increases prices. But the second order consequence was that these companies no longer competed on price, for a short time. They could justify price increases because everybody including their competitors were doing it. Since the grocery stores set the price, they determined that luxuries like 'bottled water' could go up higher since their price-sensitive customers rely more on necessities. Once supply stabilizes, these companies might start competing on price again. But in a free market, as long as their competitors keep their high margin items expensive, they can do so too.
Previously the food industry competed on price. Supply was disrupted which any econ student would tell you increases prices. But the second order consequence was that these companies no longer competed on price, for a short time. They could justify price increases because everybody including their competitors were doing it. Since the grocery stores set the price, they determined that luxuries like 'bottled water' could go up higher since their price-sensitive customers rely more on necessities. Once supply stabilizes, these companies might start competing on price again. But in a free market, as long as their competitors keep their high margin items expensive, they can do so too.
To provide another perspective, it's worth noting that the example given contrary to "gouging" doesn't account for the practice occurring in multiple industries given that it only looks at food as a share of an individual's disposable income ("the average share of Americans’ disposable personal income (DPI) spent on food").
Bottled water is a bizarre example to pick for price gouging of food, since water is available for essentially free for almost everyone in America. When it has a cost it is measured in $/kilogallons not $/liter
I suspect it was picked because for millions of American's tap water is not safe to drink.
If that is the case, it's still a horrible example because the example prices are literally 12x higher than what you can buy water for.
Please list the millions?
Unless you mean temporary boil water orders of which Canada has several dozen active right now.
Unless you mean temporary boil water orders of which Canada has several dozen active right now.
The entire city of pittsburg has ongoing lead in tapwater scandals. To a lesser extant so has the entire state of Milwaukee.
That is already millions, but...
Flint still has problems. Brady Texas has radium, Washington DC has intermittently had Lead. It is entirely on well owners to test and maintain their own water. New Jersey leads the country in BPA in water, some of which is safe, but the advice is to check with each municipality if it is safe....
And so on for all kinds of places and reasons. We just don't take tap water seriously as a country even though it wouldn't be a hard problem for us to solve.
That is already millions, but...
Flint still has problems. Brady Texas has radium, Washington DC has intermittently had Lead. It is entirely on well owners to test and maintain their own water. New Jersey leads the country in BPA in water, some of which is safe, but the advice is to check with each municipality if it is safe....
And so on for all kinds of places and reasons. We just don't take tap water seriously as a country even though it wouldn't be a hard problem for us to solve.
At least a thousan here.
Palo Alto Park Mutual Water Company, deserving about 600 houses, in the middle of the Silicon Valley. Water is not potable.
I have an extensive filtration system for making it potable. It is expensive, but the convenience is worth it as I can afford it. My neighbor has to go out refill 18L jugs for his drinking supply.
Palo Alto Park Mutual Water Company, deserving about 600 houses, in the middle of the Silicon Valley. Water is not potable.
I have an extensive filtration system for making it potable. It is expensive, but the convenience is worth it as I can afford it. My neighbor has to go out refill 18L jugs for his drinking supply.
And VC is much older than 3 years.
The rich can buy more reducing supply, raising prices.
Rich industrialists buy up raw materials, package it, and sell it leaving less raw material (or lightly refined like flour from wheat, sugar from cane) for the masses to get cheap.
We pay to cover the industrial cost of the work to package cereal rather than the cost of flour and sugar.
It’s simple arithmetic and a bunch of philosophy, platitudes, and euphemisms justifying it.
A friend of mine is a collections agent who just signs computer generated letters just to role play our socioeconomic game. Give them an equivalent UBI, and we don’t have to provide them a work computer to go along with their personal gadgets.
We produce way more than we need to to satisfy the job LARP.
Rich industrialists buy up raw materials, package it, and sell it leaving less raw material (or lightly refined like flour from wheat, sugar from cane) for the masses to get cheap.
We pay to cover the industrial cost of the work to package cereal rather than the cost of flour and sugar.
It’s simple arithmetic and a bunch of philosophy, platitudes, and euphemisms justifying it.
A friend of mine is a collections agent who just signs computer generated letters just to role play our socioeconomic game. Give them an equivalent UBI, and we don’t have to provide them a work computer to go along with their personal gadgets.
We produce way more than we need to to satisfy the job LARP.
This sounds like it was written by a (bad) ai.
yieldcrv(1)
This article says absolutely nothing of substance. It takes no side and makes no argument. "some things look like red flags. maybe that's ok. maybe it's not. someone, somewhere, will figure it out eventually." Paul Graham's blog and its consequences have been a disaster for the human race.
The author's two examples of obvious fraud were called out by many people as fraudulent years before it became public knowledge. It's possible to do your own research and conclude the zeitgeist is wrong before it becomes common knowledge. It would make the argument stronger to come up with examples where there weren't numerous experts screaming fraud for years.
https://www.theguardian.com/business/2010/mar/24/bernard-mad...