VC and gambling

Though darkness covers the earth,
and thick clouds cover the peoples...
Be radiant at what you see,
your heart shall overflow. (Isaiah 60: 1-3, 5)

Yesterday a Facebook friend commented on my latest post, "How about a post how VC is some form of gambling [with other people's money] where 4 out 5 bets fail?" 

I like when people challenge me. It makes me reexamine my beliefs, which is mostly a healthy exercise. I've found that for much of my life I wasn't truly thinking for myself, but regurgitating smart things I'd heard and read. Mostly because I wanted to be liked (I still do, but it's not my primary motivation). 

It had never really occurred to me to think of what I do as gambling with other people's money. I kind of get why it might look like gambling from the outside: risk can be construed as odds, the investment is the stakes, we frequently lose money, and the whole thing looks hugely entertaining (it really is less glamorous from the inside). 

So let's start from first principles. Founding a startup is a high-beta activity. Like other such endeavours - becoming an artist, a writer, an actor - most startups fail. But considering the expected value of success, that shouldn't be surprising. If your chance of success is 1% and the outcome yields $50 million, the expected value of being a founder is still $500,000. And if you're great at founding a company, your chance of success might be much higher. No wonder people want to do startups. 

Unlike speculation, venture is an "investive" activity. It is fundamentally meant to be creative capital, to finance building something. It isn't trading and as such it also isn't a zero-sum game like gambling. While what is financed may not blossom into a popular product or large company, the attempt occurred and that attempt had value and meaning beyond its financial outcome. Trying lots of things that don't work, it turns out, is key to evolution - not just of biological entities, but of entire ecosystems like capitalist economies. If you don't try lots of stuff, your economy will stagnate. 

The capital we raise for our funds comes from a variety of different investors - pension funds, family offices, some public funds. Usually the money we raise is part of a very small allocation within a larger portfolio of fixed income, equity, real estate and other alternative assets. Venture is usually the smallest "asset class" they invest in. Their expectation is for us to try and vastly outperform the benchmark return. 

So why do the founders, the VCs, our LPs, governments and many others want startups to flourish? The main reason is the power of exponential growth. Successful startups can become very, very big. Often bigger than incumbents in their market. Something that grows 2% a month will be 2.5x as large in 4 years. But something that grows 20% a month will be 6,300x in 4 years. That's why startups are attractive. 

Now, there are lots of subtleties to consider. For example, building a "normal" (i.e., non-startup) company might be a great life choice. Avoiding institutional investment might be sensible, too. Or at least waiting to become cash-flow break-even ("ramen profitable") before thinking about that choice. But equating venture capital with a form of entertainment (vice?) like gambling probably means trying to simplify what has become a great way to finance the fast growth of potentially important ideas.

Like anything, it's a matter of perception - being able to see the beauty in it, instead of the darkness (see Isaiah above).