Silicon Valley Firms Having Cash Showers

Carl Bialik from WSJ writes "'The market for high-technology start-up businesses is so intense in Silicon Valley that some companies are being showered with millions of dollars from investors -- without even asking for it,' the Wall Street Journal reports. The home-improvement website Done Right received an email from a well-known investment firm inquiring about putting cash into the company. 'Paul Ryan, Done Right's chief executive officer, says the missive wasn't sent to him or to his executives -- it landed in a general corporate email inbox,' the WSJ reports. 'Mr. Ryan wasn't put off by the impersonal plea: "We're having very good discussions with [the firm] right now," he says, declining to name the potential investor.' The Journal notes that 'pre-emptive' funding is, of course, risky, and harkens back to bubble-year investment trends."

Comments

Re:Changes color with age though

[Omaze]

> AT the end everyone got burnt

Not everyone. Many people knew the game ahead of time and had their exit strategy planned. The CxOs had their business insurance. The investment brokers knew how to sell the funds that would ultimately fail to the less priveleged brokers. In the end the money was raked in by the folks at the top while the losses were lumped onto the insurance companies--who then distributed the losses by raising rates on health, auto, and home insurance.

Like most things

[Aceticon]

Brought to you by the "i've been thinking about it and it really seems logic" department:

Return on investment for a VC company is dependant on a probability curve.

The cumulative profits of the companies in any given sector follow a probability distribution where small number of companies are stars, a small number are total wash-outs and a big number sits somewhere in the middle.

Depending on the sector (and the status of the overall economy) the curve might me higher or lower with relation with the break-even line (ie the average profit of all companies sits at a higher/lower profit point - or if below the break-even line lower/higher loss point).

Also, the steepness of the curve might be higher or lower (i.e. more or less companies are at the extremes of the curve than at the center). Investment restricted to younger/non-listed companies probable matches a steeper curve (i.e. more likelly to be a wash-out or the next big thing).

Since nobody knows beforehand where each companies profit will be in this curve (remember this is a cumulative profit curve - u only know it when u get there), to decrease the investment risk VCs (and any wise investor) always invest in multiple companies (each investment representing a point in the curve). Thus they decrease the risk of doing a single investment which is a total wash-out and loosing it all.

VCs try to beat the market by:

• Finding sectors where they expect the curve to be higher (i.e. better average profits) to invest in.
• Trying to predict which companies will be in the positive part of the curve and invest in them - this consists a lot of experience and guess work.
• And the major difference between a "real" VCs and an "investment fund", they try to influence the position in the curve on which the companies they invest in will end up in by providing guidance and expertise.

Still, the returns on investment of a VC are still constrained by that curve - they might get a star, they might get a total wash-out and most of their investment will be in companies that fall in the middle. I dare even say: the less a VC can provide guidance and expertise the more likelly it is that their return on investment will match the average on that sector.
A VC company whose ROI matches the market average on a sector is little more than an extra expensive fund or index tracker on that sector.