On the Evolution of Investing

Today Y Combinator announced they are adding two new partners, Garry Tan and Aaron Iba. This announcement is unique because it does not list their academic credentials, their previous investments, the boards of companies or non-profits they have sat on, how many years of experience they have, or any of the usual badges of honor investors parade in their biographies and Crunchbase profiles.

Instead we get accolades of “rare individuals who can both design and program” and “best hackers among the YC alumni.” Take note of this moment.

I was part of a dinner conversation the other night that included institutional and angel investors, entrepreneurs, and someone who was part of the YC program. The group circled with alarming intent on grilling the YC entrepreneur: “How much time did you actually get with PG?” “It’s a cult of personality.” “The average quality of the companies has really dropped as they’ve broadened.” “I can’t wait for this bubble to pop.” I believe it was mostly in jest — few topics were spared that night — but there was some truth in the defensive undertone.

The hackers and engineers of Y Combinator are doing what hackers and engineers do to any industry, they’re efficiently and ruthlessly disrupting the traditional model of venture capital and are going to destroy far more more wealth for their contemporaries than they create for themselves, as broadband did to entertainment, Craigslist did to newspapers, and Amazon did to traditional retailers. This is what outsiders, by definition, do.

The dark humor in this is that the same people who delight and celebrate investing in disrupting other industries are blind or in denial about it happening to their own.

The question then becomes if you’re an investor with a traditional LP model (and expectations), or a more financial background than an operational one, or an operational background more in management than in design or coding, what should you do to stay relevant through this shift?

26 replies on “On the Evolution of Investing”

I think the dirty little secret is that, aside from the top-tier VCs, it’s not clear anyone else ever made good risk-adjusted returns, outside of a short window in the late 90s.

There is disruption going on upstream.

Second markets are disrupting the IPO pipeline.

Independent high-frequency trading has taken over marketmaking from cartels of floor brokers and banks.

Independent registered investment advisers are disrupting stockbrokers.

Individuals are taking charge of their own portfolios with online tools, blogs, communities like StockTwits.

Still some cartels and dinosaurs ripe for disruption.

The shift away from traditional credentials like degrees, honors, and past accomplishments has been gradual.

In the ancient days, people focused on brands on resumes–which school did you attend? Which companies did you work for?

When I was at D. E. Shaw in the 90s, we had a specific list of 25 CS departments we were allowed to recruit from. Resumes from other schools were automatically filtered out.

The shift to accomplishments was actually progress–rather than relying on brands, we actually cared what people had done. But this was still somewhat unreliable because of the major role luck plays in success.

YC’s accomplishment in these hires is to focus on ability, independent of resume brands or the magnitude of accomplishments. EtherPad was a great product (disclosure, I was an investor) even though Google shut it down after the acquisition. Posterous is a great product, even though its traffic and traction are overshadowed by Tumblr.

I also think that YC is very smart to focus on design and coding for its hires. As an accelerator/seed firm, YC deals with very early stage startups. I often tell founders that until they have a great product, outbound sales and marketing are a waste of time.

But I also want to be fair to the many traditional VCs who do a good job. As a company grows beyond the YC stage, considerations like sales, marketing, operations, and people management become increasingly important.

Many of these are issues that can only be dealt with based on experience, rather than on what one reads in Hacker News. As you grow, traditional VCs and other grey hairs can actually help (though they don’t always do so).

There is such a gaping void in investing that no-one is covering. These ‘bubbles’ (YC incubators & Kickstarter style crowd funding) are the first attempts at pushing towards filling it.

It’s the smaller investment.

The level of investment that is ‘just enough’ to bring your product/service to market.

Not only is it what first-time founders want, better companies will be built because of it. Decisions will have to be solved through innovation & logic not by throwing startup funds at core problems.

The players may be changing (at least at YC) but the game is the same for entrepreneurs: give away 7% equity for $20k (who does that??) and the privilege of being associated with a premium brand – a brand that adds limited value outside of silicon valley.

This is not disruption. This is rearranging the deck chairs on the titanic. Or at least getting new people to sit in them.

So far YC has helped increase the number of startups looking for VC money, so if anything they have been a boost to VCs (and YC themselves have taken investment from traditional VCs like Sequoia). The most disruptive thing that could happen to VCs is the next Google or Facebook figuring out a way to bootstrap itself all the way to profitability.

Why would an investor with a strong operational background in design or coding be more valuable than a background in operations or management? Having a cursory understanding of each area is important, but I often don’t often see entrepreneurs looking to investors to fill these gaps.

The things you note in your post are really only a function of the cycle we are going through. We invested in building a new communication medium (the internet), the infrastructure to support that, the platforms on top of that infrastructure, and now we are building applications on top of that.

It doesn’t take a lot of money or time to invest on top of this big stack to create applications. However, investments in developing arenas like biotech and green tech generally require large dollars because they don’t have the infrastructure noted above.

Dollars invested should always be a function of the market opportunity. Sometimes we lose sight of the fact that the market controls it, not us (whoever us is). The market doesn’t care if you have $300 mm fund or $300.

Soon what’s old will be new again.

More intermediaries getting disintermediated…

Per your final question Matt, many of the people being made redundant through this shift cannot stay relevant in their current roles because the roles themselves (not the individuals) are redundant.

The answer for each of them can only exist outside a dissolving status quo, and it’s up to them to redefine themselves rather than expect to ride through this chaos on their current job description.

Druce mentions the disruption going on upstream. I think part of this disruption is sheer creativity of entrepreneurs to find finding through less traditional channels. Debt has dried up. Hundreds of bizplans on VCs’ desks lying unread. Crowdfunding is on the rise – and about time. When it comes to early stage ventures at least, I’m all for entrepreneurs finding non-VC funds for their start-up.

Good commentary. I wonder if the amount and type of investors is actually increasing so fast that people with traditional concept of investing in their mind are getting stuck with the past. Yes, rich will always rule over the weak and poor (sadly so), but new ways of Kiva, Kickstarter, etc. will change more than traditional big money can. It’s about getting involved and actually caring about what happens with the resources and giving the inventors (instead of investors) and creators will and support to create world with better things.

It’s great that people have the ability to evaluate and invest but the types of investments have been way out of what people have been used to. There is need for both big and small money and it’s more about the concept of collaborating and sharing the burden than just at ripping maximum personal returns from the investments. Yes, there is need for both but hopefully people would do wisely and invest in things that make life better for all.

All cycles have stages and always good to spot the shift from one phase to another. Not always so easy to do as we all know. YC is filling the funnel and hot housing because that works at that end of the circuit.

Sean Gourley & the clever folks at right there in SF have some smart visual modeling tools which means some of this shift can be measured and spotted much earlier. Before Quid they tracked a fair sample of the startup activity via Younoodle.

Much of what worked in the in the early days was a combination of luck, experience, timing ( portfolio theory) and a certain amount of strategic thinking about where to look.

A simple analogy is connecting the dots between data points. With a fractal pattern, better tools , better analysts (still luck) picking patterns in much wider, deeper samples is now possible.

OTH – I keep a copy of Paul Grahams Hackers & Painters by my bed & re-read some of those stories often because inspiration and visionary leadership is still important.

Anyone out there who wasn’t in diapers when the crash happened? Way too many folks investing in low barrier to entry companies with no profits or revenue who think they have the world figured out. When groupon, angieslist, etc etc go bankrupt and facebook has a market cap of 9 billion, you can say you heard it here first.

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