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The Almighty Buck

Lawsuit Could Expose Whether Top VC Firms Are Actually Good Investments 90

curtwoodward writes "Venture capitalists like to project the image of wise kingmaker, financial alchemists who have a unique gift for spotting the Next Big Thing. They do not like having anyone see data about their performance, which has been generally lackluster over the past decade. This can be a problem, however, when VCs cash big checks from investors at public pension funds — taking taxpayer money sometimes comes with public disclosure. That's the crux of a court fight happening in California, where the state's massive university system is resisting attempts by the Reuters news organization to decode a complex shell game intended to hide the return data of two giants of Silicon Valley: Kleiner Perkins Caufield & Byers and Sequoia Capital."
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Lawsuit Could Expose Whether Top VC Firms Are Actually Good Investments

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  • by alen ( 225700 ) on Thursday March 28, 2013 @08:51AM (#43302383)

    every day they are hyping some tiny startup that is a copy cat. a year or two ago it was a new social media start up every week. then after square became popular there were payment startups every other day.

    figures i've read before are 7/10 VC investments lose money. 2 return the investment value. and one is a facebook or google returning many times its original investments

    • by Anonymous Coward

      every day they are hyping some tiny startup that is a copy cat. a year or two ago it was a new social media start up every week.

      A simpler explanation is that techcrunch only has articles about stupid companies.

      I have worked at three small companies. Two were VC-funded. The other was funded with a reverse mortgage on the founder's house. All three involved improving yields in semiconductor manufacturing (and all three had different approaches to this problem). All made quite a bit of money.

      None of these companies will never be on techcrunch, because understanding what they do requires use of your brain. Techcrunch wouldn't write

      • But they also make a REAL product that they will "sell the company" to Intel, TSCM, AMD for "reasonable" amounts of money if their work pans out.
        The work is known, the players are known, the exit is known... They have a high risk problem... But it's a DEFINED problem, with an answer worth a certain amour of money... It's not "blue sky" research. Those aren't "gamble startups" where VC is expecting 100 fold returns for customer facing websites.

    • Why do you think VC is considered "high risk"? That's the game they are in, and I think your ROI expectations are way too optimistic.

  • by Anonymous Coward on Thursday March 28, 2013 @08:52AM (#43302393)

    Venture capitalists ...financial alchemists who have a unique gift for spotting the Next Big Thing

    No, they don't. What they do is invest in many different things that they think may have potential - they spread their bets. Couple that with deals where they get paid first at the ROI they demand (+40%), screwing over the initial founders in the process.

    AND they use other people's money while making sure they get a big cut in fees and whatnot because of their "expertise" while giving their investors returns that don't quite warrant the risk they are taking.They, the VCs, can't lose - the founders and the investors take most if not all the risk.

    The only thing these guys have is connections to money and a lucky hit or two.

    • by SJHillman ( 1966756 ) on Thursday March 28, 2013 @09:03AM (#43302493)

      Read the words that you skipped over. It clearly says that is the image they like to project, not that's what they actually are (actually, it goes on to say that they're just the opposite of their image).

    • I know what you are saying, but I disagree.

      If you want Alpha you hire a hedge fund for their expertise. For the examples given, Sequoia et.al., they will invest in 20 high tech startups. Which, from the broad market perspective, is not spreading your bets. This gives you Alpha – a special extra return over the normal market return because of the managers skill (or luck – it is always better to be lucky then good.)

      If you want to spread your bets you but a index fund – you get the Beta and a

    • AND they use other people's money while making sure they get a big cut in fees and whatnot because of their "expertise" while giving their investors returns that don't quite warrant the risk they are taking.They, the VCs, can't lose - the founders and the investors take most if not all the risk.

      It's not true that they cannot lose. While typically it is not their own money at risk (though sometimes it is), if a VC is unsuccessful with a fund they often find it difficult/impossible to raise money for their next fund. The risks to the VC are typically more long term. If I'm a big pension fund manager investing with a VC fund and I don't receive a return on my investment, I'm not going to invest with that VC again most likely. The VC community isn't a very big one and the people who invest in VC

  • This just in (Score:4, Insightful)

    by wbr1 ( 2538558 ) on Thursday March 28, 2013 @09:03AM (#43302495)
    People who gamble others' money loathe to disclose depth and depravity of their addiction.
    • Re: (Score:3, Insightful)

      by khallow ( 566160 )

      People who gamble others' money loathe to disclose depth and depravity of their addiction.

      Nonsense. They just don't want the marks warned off.

  • by the eric conspiracy ( 20178 ) on Thursday March 28, 2013 @09:04AM (#43302505)

    Whether or not the returns from private equity are better than the public markets has been controversial for a long time.

    However it is well known that other aspects of these markets are undesirable for investors. Lack of disclosure, poor liquidity and negative scaling are some of these.

    http://www.economist.com/blogs/freeexchange/2012/09/private-equity [economist.com]

    Given the lack of clear benefits and the well-known problems with these funds it's pretty obvious that pension funds should not be invested in these instruments.

    • I too read the Economist but I come away with a slightly different reading.

      Alternative assets actually are a good thing for pension funds to invest in. For example, lack of liquidity means the assets are cheap, which means you get superior performance over the long term. Hedge funds have a lock up period of 10 years, pension funds invested for people working today won’t be needed for 10 years. It is a perfect marriage.

      Now, for the last 10 years everybody and their dog have been piling into hedge funds

      • I would tend to agree; investments for the "very rich" including pension funds are much more about long-term stability and comfortably beating out inflation than trying to get 10 points above the broader market return.

        My issue with it though is that the management fees for mediocre return are way too high.

      • Lack of liquidity also means higher risk. It means you cannot get out of the investment if it starts to go sour.

        It is not a perfect marriage at all. It's taking on more risk than the more or less average returns justify.

        Hedge funds are more or less in the same category as private capital. Poor disclosure, high expenses and poor liquidity. The result is a lot of risk that isn't justified by the returns. Ask the folks who had money in MF Global or Long-Term Capital Management how they feel about the importan

        • So, to clarify, speaking about high and low risk is kind of pointless, you need to look at the risk / reward ratio in a diversified portfolio. Ccompare these 2 indexes

          MSCI REIT Index – which tracks REITs - real estate trusts that trade on the stock market (i.e. liquid)

          FTSE NAREIT – which tracks returns from real estate partnerships, hedge funds, etc. (i.e. not liquid).

          The illiquid FTSE NAREIT consistently offers better risk / reward and

          • That's the thing though. The higher risk is not always rewarded by sufficient returns to compensate for the risk. Hedge funds and private capital are cases where the tradeoff is pretty questionable.

            REITs though are one of the alternative investment classes that are most worthwhile.

      • I agree with the idea of alternative investments as being worthwhile. For both personal and institutional investors.

        However the fact is that there are not many alternative investments that are actually beneficial. Most just add risk without commensurate returns.

        There is a really good introductory book on the topic if you are interested into getting in to the nitty gritty.

        http://www.amazon.com/Only-Guide-Alternative-Investments-Youll/dp/1576603105/ref=sr_1_1?ie=UTF8&qid=1364494591&sr=8-1&keywords [amazon.com]

    • Why did public pensions invest in venture capital firms in the first place? Years of ever-escalating pension benefits plus years of severe underfunding those same pensions [battleswarmblog.com] means that they needed unrealistic growth rates to even come close to meeting their targets.

      Take California for example. Not only did they keep increasing pensions promises while underfunding them, they used a variety of accounting tricks [california...center.org] to cover it up. On top of that, they assumed unrealistic returns (7.5% or higher in many cases).

      How could they get away with? California has essentially become a one-party state where public employee unions are the most powerful interest group. So the process is:

      1. Public employee unions use mandatory union dues to contribute to Democratic candidates.
      2. Once elected, Democrats vote for ever escalating pension benefits.
      3. Democrats appoint pension board officials who ignore underfunded pensions. And the CEO of CalPERS, California's largest pension fund, was just indicted for fraud [go.com]. "The indictment charges that the falsified documents allowed Villalobos to reap $14 million in fees for serving as a middleman between CalPERS and a prominent investment firm handling $3 billion in CalPERS' money."

      Combine this with ever-higher taxes, and a faltering economy, and you have a recipe for the governing class looting the treasury at the expense of the middle class (and future generations that will have to deal with the consequences of bankruptcy and crushing debt loads). Several California cities have already declared bankruptcy, and newer, more transparent accounting rules will probably force more into bankruptcy [dropoutnation.net].

      VC funds are probably the least of their worries.

      • by ediron2 ( 246908 ) on Thursday March 28, 2013 @12:51PM (#43304825) Journal

        Given the presence of Hollywood, Silicon Valley, defense contractors and farming economies like the Imperial Valley, implying that public employees and their union are omnipotent is laughable.

        Your economy isn't faltering. Some areas were gutted by industry itself (manufacturing), some have tech-related disruptive challenges (movies/music), and farm revenue and silicon valley revenue are booming. Your tax rate above 200k income remains at record lows, percentagewise. Your tax rate overall is slim compared to years ago. Even CalPERS has trimmed down administrative costs steadily in the last 5 years (http://www.calpers.ca.gov/eip-docs/about/facts/general.pdf)

        Individual corruption is a red herring, too. Shine some light into those dark areas, root it out (corporate / private or public), and we'll... oh, wait, that's already being done.

        The problem in Cali is the same as everywhere else: mere working stiffs not seeing any of 40 years of prosperity vs. corporate and 1%er's taxes plunging. Add in your state's epic damage from Prop 13 and similar right-wing nuttery, and you've created this economic pinch. Stop blaming the last bastion of union/pensioned people: when most of them got their jobs, they took lower pay in trade for stability and a pension. The problem isn't them, it's that you've screwed so many other middle-class people in the state and propped up banksters and billionaires with the proceeds until public employees' situation looks enviable enough to the rest of the citizenry to assault.

        • by Anonymous Coward

          Shhh... stop pointing out that between income taxes, property taxes, sales tax, fuel tax, Social Security, and Medicare they're paying as much as 45% of their income in taxes while an investor can use long term capital gains tax to pay 15% only on the investments he cashes out and that if you add together property, sales, and fuel tax that puts his total tax rate at 20% tops.

          I have nothing against Sergei Brin, but let's use him as an example. His personal wealth can easily grow over a billion dollars this

  • Luck.

    Really, that's it. All the other less successful VC firms have the same tools of the trade and people that are on average about as good at spotting a winner. The difference is that the successful firms have their 5% bet pay off 10% of the time rather than 0% of the time.

    • Marketing, not luck.

      The investments do not actually need to pan out. The VC firms just need to make their investors think that the investments will return, and the VC firm makes money in fees even if the overall return is low.

      It is a casino for the investors. The VC firm is the house.

    • For some hedge funds this is true – but not for VC. On one side, a startup can only take funds from a limited number of people. On the other side, startups tend not to have audited financial statements, so it takes a lot of leg work for the due diligence.

      • by sjbe ( 173966 ) on Thursday March 28, 2013 @09:44AM (#43302911)

        On the other side, startups tend not to have audited financial statements, so it takes a lot of leg work for the due diligence.

        Audited financials are somewhat overrated. See Enron. It's not terribly hard to make financial statements too confusing to interpret. I defy anyone reading this to look at the financial reports of any large bank and tell me how much risk they are exposed to or what their investment portfolio looks like. A VC will still have to do a ton of legwork for any company they plan to invest in.

        Disclosure: I'm am a certified accountant.

        • by alen ( 225700 )

          isn't that because there are lots of things a bank can hide off the public financial records? Not totally hide them but only make a small mention of some investments in the small print and keep the numbers off the main financial statements

          • As of today, not so much.

            You are probably thinking about Special Purpose Vehicles. These tend to be narrowly construed financial companies where one can park matched assets & liabilities. Back in Enron’s days, one could sell 5% of that company and get all off the liabilities off the books. In Enron’s case the SPV had full recourse back to Enron, so this was little more than a fig leaf. (In Enron’s case, the 5% equity was dodgy, the matched assets were dodgy, etc.). I would recommend

          • by sjbe ( 173966 )

            isn't that because there are lots of things a bank can hide off the public financial records?

            They don't need to do that although that has been a tactic used in the past. A bit less these days, post Enron. The bank simply needs to be vague about exactly what the composition of their investment portfolio is and ALL banks are rather opaque in this respect. Furthermore certain financial instruments are extremely difficult to evaluate. It's difficult to tell sometimes whether a derivative is a hedge or speculation or what the risk is. As an outsider it can be extremely difficult to evaluate the lev

        • And I was not trying to say that audited statements were fool proof – as you have pointed out the can be window dressing or wholesale fraud. Financial Shenanigans by Howard Schilit is a good book on the subject.

          The point I was trying to make is that for a public company everybody has access to the same level of data. Anybody can go to Edger and get them – it’s not like VCs have a magic wand – in theory they make their money though their application of superior wisdom. (Unless you are

        • It was Enron making their financials too complicated to understand that brought about it's downfall. People who were knowledgeable looked at it and said "WTF? no way all of this was real" and started betting against the stock. That betting crashed the stock and then the company.

          Whether it is fair or not is something, not everyone has the knowledge to research everything in detail. But if there was nothing there, then it never would have been exposed for the fraud that it was.

  • It seems more like someone wielding a shotgun in the dark shooting at targets. As long as he's got enough ammo, he will succeed.

    • True, but 300 shells to get one duck is not a good ROI.
      • by DogDude ( 805747 )
        True, but it is if you're using somebody else's shells.
        • That's the secret. Oh, and you get to pocket some of the shells just for showing up claiming to know how to hunt.
      • by Anonymous Coward

        It's a good ROI if the slain duck can be traded for 500 shells.

      • It is if you can sell the duck for enough money to buy 400 shells.

      • True, but they ain't duck hunting.

        VCs shoot at much bigger targets. Basically what they do is they ponder how many shells they'll need to slay it, then calculate how many shells they could buy with the revenue of the carcass, and when B trumps A, they start firing.

        The "high risk" comes from the fact that both are just estimates.

        • The "high risk" comes from the fact that both are just estimates.

          Estimates? Following Orwell's rules for plain English, that should be changed to "guesses". And since they insist on a big cut regardless of how good their "estimates" are, you can infer how much confidence they have in them.

  • by GodfatherofSoul ( 174979 ) on Thursday March 28, 2013 @09:56AM (#43303039)

    The stock market is now a sucker's bet. There's too much underhanded wheeling and dealing going on. Warren Buffet gets a sweetheart no-risk deal to buy up GM (?) stock, then the papers report he's investing in Detroit so that the rest of the sheep will follow. Jim Cramer built a career pumping and dumping stocks and the guy got a SHOW out of it! I took a look at investing years back and came away thinking I should avoid it like the plague (unless you've got a buddy on the inside of a deal).

  • by PPH ( 736903 ) on Thursday March 28, 2013 @10:36AM (#43303445)

    Being involved with some VC myself, one of the things that we value highly is the proprietary nature of our operations. If we advertise our strategies, others will try to get in on the deals. This will drive prices up and dilute the potential return on our investment. In a market where survival means making a 60% return on one out of three startups and seeing the other two go bust, that would kill the VC business.

    The alternative (which we practice) is to tell people with a duty to publicly disclose to kindly go f*k themselves when they try to buy in. There's plenty of money around and my heart wouldn't be broken if us wealthy people made 20% returns per year while the teachers union pension makes 0.1%

    • Nice line of BS Daddy Warbucks, but you overlooked that they want fund performance from ten years ago.
      • by PPH ( 736903 )

        In this case, They == Reuters

        Reuters can go f*k themselves. Our fund keeps our investors informed and happy. Don't like our rules? Or can't live with them because of regulations or judicial interference? Take your money and go home.

        • Reuters can go f*k themselves.

          An interesting argument. Perhaps you could submit an amicus curiae brief to the court.

          Our fund keeps our investors informed and happy.

          Of course it does. Why would anyone ever think otherwise? Extreme secrecy is always used strictly for legitimate business reasons, just like the state secrets privilege [wikipedia.org] is always used for legitimate national security reasons.

          Take your money and go home.

          Exactly what UC did ten years ago with their Kleiner and Sequoia investments, yet Kleiner and Sequoia are fighting tooth and nail to prevent disclosure of performance data from a decade ago. Oh, that's

  • Venture Capital is a glorified name. Let's call it what it really is - junk bonds.

  • by Anonymous Coward

    I've worked with many VC firms over the years even working for one once. Everyone has to remember that the business of VC's is to find places to invest other peoples money. It's a lot harder than it sounds. One of my jobs was to read business plans by the hundreds. 99.99% of them were total junk, written by people who were totally clueless. Of the remaining .01% most were really pie in the sky ideas. Of the ~1000 business plans I read over the course of a year I think the VC firm invested in 2 companies onl

    • I believe everything you wrote, but having somebody read through hundreds of business plans does not justify the skim that VC's take.
  • There are different types of VC firms, but overall, I think they are for investors who have a generally high risk tolerance.

    I recently attended a conference and saw a presentation by a guy who was part of a small VC firm that funded startups. They understand and expect that many of the "ventures" will be losers. They even expect that they will invest in more losers than winners overall. They're betting on finding a small number of ventures that really take off and provide big returns that will compensate

    • Boilerplate. Everybody who's heard of VC understands and accepts everything you said. It has nothing to do with disclosing the performance of funds from 10 years ago.
  • Hi all, author and submitter here. Sorry about the link problems - it's all my fault. I edited the headline to make Sequoia possessive, to avoid confusion with another fund. To be OCD about it, I also added the 'S' to the URL. Which means a ton of you bonked the 404 page when you went to read the article. Never edit before coffee. So I have changed it back. This one works again: http://www.xconomy.com/national/2013/03/27/kleiner-sequoia-fund-returns-could-be-exposed-in-ca-lawsuit/?single_page=true [xconomy.com] Thanks to

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