Chasing Returns

I've spent much of this long weekend curled up on the couch reading Too Big To Fail, Andrew Ross Sorkin's history of the financial crisis of 2008. I've wanted to read this book since it came out last year but it took me a while to get to it. I'm enjoying it very much.

As I read about bank after bank waking up and smelling the coffee too late, I am reminded of the risks of chasing returns. In the case of the financial crisis of 2008, the banks were chasing returns in the mortgage markets and the related markets for CDOs and other exotic derivatives. The scary part of the whole thing is they were chasing returns in a market they did not fully understand. Here's a quote from Alan Greenspan that I got from the book:

I've got some fairly heavy background in mathematics. But some of the complexities of some of the instruments that were going into CDOs bewilders me. I didn't understand what they were doing or how they got the types of returns out of the mezzanines and the various tranches of the CDO that they did. And I figured if I didn't understand it and I had access to a couple hundred PhDs, how the rest of the world is going to understand it sort of bewilders me.

Andrew follows that quote with this observation:

He was not alone. Even the CEOs of the firms that sold these products had no better comprehension of it all.

But the CEOs knew they were making billions in these markets and they pushed their firms to go farther and faster in search of more billions. That is called chasing returns. And it is the most dangerous form – chasing returns you don't understand.

I have a friend who has worked on wall street for forty years and runs a large fund of funds. He told me his biggest red flag when he reviews the performance of the funds he is invested in is when the returns are "too good." When he sees that he gets on a plane and goes to visit the fund manager to understand where the returns are coming from. If he can't understand it, he withdraws from the fund, no matter how good the returns are.

I'll take this conversation back to a market that I do understand – venture capital. The venture capital business is showing good returns for the first time in a decade. The sectors that are performing best are web services and early stage/seed investing. These are sectors we have been investing in for over fifteen years. We've seen these sectors boom and bust before and we'll probably see it again. We are committed to these sectors and have no plans to leave them.

However, these sectors of the venture capital market are filling up with investors chasing returns. And some of them do not understand what they are investing in. I got a call a few weeks ago from an individual investor who wanted to invest in one of our portfolio companies. He asked about the company and from his questions it was pretty clear he did not understand the business very well. He went ahead and made an offer to invest. That scared me.

I've been visited recently by a number of foreign investment vehicles, many of whom are investing billions of dollars of sovereign wealth. They all want to get into our funds and our deals. When I talk to them about why, they can't really articulate a cogent argument about the economic potential of the social web. But they see the returns and want some of them too. That scares me.

The venture capital markets work well most of the time. Venture capital is not financial engineering. It does not involve slicing up securities into parts and selling them off in baskets (until recently). It is about making an investment to turn nothing into something. When that something becomes a real business, with real customers, revenues, and profits, the venture capital investor is rewarded with a return, often times a very good return. I do not think venture capital will ever turn into the kind of mess that the mortgage markets became three years ago.

But I do think we are seeing signs of excess in the markets we invest in and I do think we are seeing investors chasing returns in deals they don't fully understand. That is a red flag. And I am choosing to observe it, pay attention to it, and share it with all of you.

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#VC & Technology

Comments (Archived):

  1. CliffElam

    Well, I can’t comment on what you’re seeing, but as a guy who has been through the washing machine a few times, my BS-o-meter is pretty pegged right now. Definite flash backs to the last bubble.Partially, I assume, this is because Facebook and Twitter don’t do much for me, so my “get it” is purely intellectual. (To the degree that my teenage daughter would grant me an intellect!) I do get stuff like Groupon (ValPak for the web, yeah, cool) but a lot of what goes hot (badges? what?) is baffling to boring old B2B me.So what you’re seeing from your side is also making me hesitate on a very good business idea/plan that we’ve been working on for almost a year. We’ve got two early customers signed up, we’ve “socialized” it with 20+ smart people who have failed to find an Underwear Gnome Flaw (UGF), etc, etc. I think we could pretty easily raise a first round. But why would we if there is a bubble going to pop in 6-18 months? Where would our second round come from?I guess you could say that the Round-B close risk is approaching too high a number for us. We reckon waiting out the bubble burst and then financing would be smarter. We aren’t concerned with a few million valuation over/under on the Round-A, we’re worried bout the presence of follow on rounds.-XC

    1. Fernando Gutierrez

      If the business is good, you’ll be able to raise that second round, no matter the times. Even in the worst of the crisis or enviroments there is someone making huge money.And if you wait someone else will fill that gap.

      1. CliffElam

        I’m not worried about someone else executing – we see a lot of people around the edges of the idea building out pieces. I think it is a lack of vision plus a lack of capability, certainly it doesn’t seem to be a lack of money. A year won’t matter. And if it does, well, there are many ideas in the world – I think you have to bring together ideas, customers, and team.And I remember post the last bubble and post-911 what happened to the funding market. Think Sahara but with less water. Companies with signed term sheets from real companies fold to “go sue” because nobody could make a call. I’ll take a pass, thanks.-XC

  2. Michael Lewkowitz

    Same goes for entrepreneurs. Chasing returns returns doesn’t often end well. People, purpose, passion and relationship ftw!

  3. David Noël

    Too Big Too Fail was one of my favorite books this year, total page-turner and a real-life thriller – unfortunately. If I could have chosen between The Social Network and a movie adaption of Too Big Too Fail, I would have voted for the latter. Way to make the events approachable to general public, as an attempt to better understand what has happened so that it never happens again. The book definitely is movie-material.

    1. Gary Sharma

      Its being adapted into a movie for HBO

      1. David Noël

        Interesting, just searched for it, sounds promising. Thanks!

        1. paramendra

          Hey SoundCloud, how is it going?

      2. paramendra

        I think I saw the trailer.

  4. William Mougayar

    This sounds like alarm #3. And I agree with your level of apprehension, although you may be appearing as the conservative voice amidst this new cycle of technology gold rush. (But I’d rather be conservative and prudent than reckless and liberal- and still be part of it).To the sovereign investors, why not invest in technology in their own countries? That would be better for spreading wealth creation more evenly in the world.Back to the financial markets situation and the book you read, the point is- have we learned? And are we doing things more prudently now? I’m not sure about that. Couple of recent scary headlines:- Taleb Says Bernanke Doesn’t Understand Risks of QE (what the heck is QE2!)… – Corporate Profits Were the Highest on Record Last Quarter (so why are people not doing as well when corps are? something is wrong & add to it that employee satisfaction in big corps is pretty low too. Big corps are squeezing and squeezing)

    1. JLM

      QE (quantitative easing) is what you do when you are already the town slut and you want to lower your reputation and the esteem that you are held in by the financial markets even further.QE is the term that folks use when interbank rates — interest rates, discount rates, interbank rates — are already at zero and you cannot really just let folks come to the bank and print their own money using their own paper and ink.When you are devoid of ideas and nothing is working, you jump on QE.Japan practiced QE for over two decades to no avail.QE is like a hooker banging the Pope and suggesting that the quality of the John is a proxy for regaining one’s virginity.We have a very simple dilemma just now — JOBS!Unfortunately, we are currently in very low supply of reasons to create jobs and we are being led by folks for whom this is not a strong point.

      1. William Mougayar

        LOL. I love your euphemisms.

        1. Donna Brewington White

          He turns it into highest art.

      2. Matt

        If the QE actually ends up sowing the seeds of the economic inevitibility of a coming rising market, is that necessarily a bad thing? This time around the innovations we need were deftly avoided by Stimulus Funds (accident?) so the cash could go to a bunch of corporations with no technology in the pipeline. Hence, we were left out in the cold.You want jobs? Do you really? So do I I want to create as many jobs a s possible, but I haven’t found anybody yet who wanted to create jobs enough to be willing to be paid their up-front fees, at the back end because we have no other option. We started our company before a number of the expensive to get over hurdles were placed between us and funding. Planning could not manufacture capital. We’re still here because we refused to join in with others and lie to people like you.Those who did as predictably as the Sun rising in the morning failed, losing a lot of capital in the process. Is the investment/vc community ready to stop playing games now? If 5 of us worked together, with our technologies we could stage a green economic coup d etat. All I want to do is prove our technology would support such an idea. We have a prototype to be tested. We’re ready to go. We want to commercialize what we know very badly, because it works profitably. All it takes is a visionary with a checkbook and we could be breaking ground for full-scale production of algae based biofuels within 12-16 months. Lead time is also compressible with adequate funding. All it takes is the willingness to accept payment for a raise at the back-end. That’s all, just willingness, nothing more.

        1. JLM

          QE 1-10 is unlikely to have a dramatically different outcome for the US than it did over the last 20 years for Japan. It is hubris to suggest that we would be better at zero interest rates because there are not many moving parts when rates are that low.What the country needs is jobs and jobs will be created by small business — always have been — because all the improved bottom lines by the Fortune 500 are created primarily by cost reductions touted as “productivity gains” and ridiculously low costs of funds due to low interest rates.Cost reductions, productivity gains are euphemisms for job cuts.I have raised over $1B of OPM in my life and unfortunately there are no secrets — get your pitch, get your tin cup, get your knee pads and hit the road. The good news is that there is a lot of money out there.If I were in your shoes, I would go locate the 300 largest private oil companies in the Oil Patch — where some guys last name is on the front door — and start kissing frogs. These are the guys who are cashing $80/barrel royalty checks. They are flush and they will understand the economics of your deal.I would go mine the state sponsored “opportunity funds” of each of the Oil Patch states — Tx, La, Ok — and promise to put my plant in their state in return for a bit of funding.Good luck.

          1. Dave W Baldwin

            This is exactly how those who wish to really make something happen need to talk!

        2. Dave W Baldwin

          Hang in there. Those with something truly disruptive need to push. Yes, it would be good to get collaboration and/or cross pollination across markets.Otherwise, referring to JLM’s jobs statement, people better realize if a company lets go of however many workers and can still fill orders, they are not looking to bring their number of employees back to where they were. Then, depending on the sector, their customers continue to squeeze the price which continues the ‘do more with less’….

  5. LIAD

    Why hold the sovereign wealth funds to such high standards?Can your LP’s articulate cogent economic arguments about the social web?

    1. JLM

      Not perfectly on point but it is useful to know that there is a huge difference in the behavior of pension fund money and sovereign wealth funds.The pension fund is ultimately constrained by an internal portfolio allocation model — equities, fixed income, real estate, VC, all other — while the sovereign wealth funds are really just pools of money with questionable internal discipline.The pension fund has to fund the pensions. They are highly regulated. If they blow it, people will suffer.The sovereign wealth funds have only to please some individual or government and can farm out quite broadly doing whatever they intend to do. If they blow it, in many instances they just have to keep pumping oil.

      1. fredwilson


      2. LIAD

        I’m sure the vast majority of $ invested each day on the stock market is not done through solid analysis but something more pertaining to a crap shoot.Isn’t chasing returns the epitome of the American dream?

        1. JLM

          The big secret on WS is the continuing flow of 401K funds which arrive each and every quarter.I suspect that less than 25% of Americans have changed their 401K allocations even in the face of disastrous returns.Once these allocations are made, they have to be met. 401K fund managers just keep buying the same stuff.If 401K money were withdrawn from the market for a year, PEs would decrease proportionately to a kissing cousin of CD returns.The American Dream is to work your ass off, make a buck, educate your kids and then get to keep what you made. The American Dream is founded on hard work and being able to direct, keep and enjoy the fruits of your labor. The American Dream is in a hard scrabble fight with the current administration and the contest is not yet decided.

          1. reece

            I was indirectly talking about the American Dream with my dad last night…He’s looking at the potential sale of the family restaurant and a pseudo-retirement (at 56) from the business after 35 years of really hard work.My sister’s worried that selling now, in a down market, won’t earn them the kind of money they really need to retire (even if it is valuable waterfront property on Cape Cod) and that her and I will have to step up if she’s right.Last night, my dad calmly rationalized that 27 years ago, he left a great paying job as a chef to start his own catering business while my mom was pregnant with me and already had my sister. Oh yeah, don’t forget the mortgage, car payment, etc…But he did it and they made it work.1 catering business, 1 successful restaurant ran for 15 years and sold, 1 floral/decorating business ran for 5 years and sold and now the current restaurant, successful for 15 years as well…So he looks at the initial cash he put up to buy the current restaurant, the potential earnings, (north of 14x that cash), being debt free and the fact that as a kid, his peers were putting needles in their arms and ending up in jail and says…’If we made it work back then, we can certainly make it work now. I’m not worried about holding out for the market to return, because I’m not concerned with leaving you and your sister a bunch of money… and after all, it’s only money.’

          2. JLM

            Your Dad and your family ARE the American Dream.The toughness that he exhibits is what built America and what has allowed the next generation to stand on the shoulders of the prior generation and to see beyond the horizon.

          3. reece

            Thank you. That is a huge compliment.I am forever grateful in this regard as I am able to chase my dreams of building a business because my parents put me in a position to do so.

          4. Donna Brewington White

            ” ‘…and after all, it’s only money.’ “And it looks as though you’ve already received your inheritance anyway in terms of an inspiring legacy.

          5. reece


          6. ShanaC

            So true.

    2. fredwilson

      some can and some are learningwe’ve been talking about these issues with them for seven years now

  6. Fernando Gutierrez

    That quote from Greenspan makes me think that total regulation is not possible. If in the other side you have a huge number of brilliant people chasing big money you can’t do it with a couple hundred PhDs and a heavy background in mathematics. People should understand this and invest accordingly only in what they personally understand, not in what they are sold thinking that the government is taking care.By the way, another great book about the crisis is Scott Patterson’s: The Quants. It’s not all about the crisis but it explains quite plainly some of the factors that led to it.

  7. JLM

    I must admit up front to having read just about everything that has been written on the recent financial melt down, knowing a few of the players and concluding that it was completely avoidable had there been the exertion of just a tiny, tiny smidgen of common sense and restraint.Common sense and restraint being in woefully short supply in both Washington and Wall Street.The politicians — not casting blame on a particular segment but I do have my favorites — through flawed and tainted public policy allowed an investment/portfolio mix challenge in the GSEs to become a public market and industry problem by not only allowing but also encouraging the extension of credit to folks of highly questionable financial pedigree at levels of financial risk they would have choked on even if they were credit worthy.They took their eyes off the realities of the basic numbers.They not only allowed some folks to borrow, they allowed them to “over borrow. They forced everyone to assumed to be credit worthy and to think otherwise was to be a bigot.The creation of exotic securities went against the most basic concept of finance — how do we collect on our collateral if the deal doesn’t work? When 20-somethings design securities around mathematical algorithms with the premise that theoretical debt service coverage is a substitute for fundamental underwriting and asset quality — checks and balances should have been in place to keep the explosives and the blasting caps separated — disaster awaits.The most fundamental assessment of any investment is — what is the quality of the borrower and the asset? What is the collateral really worth?If the deal does not work how does the “cat get walked backwards”?Of course, none of the designers — admittedly brilliant chaps — had ever had to collect on a piece of collateral or roll up a failed investment.This is where the SEC should have simply stepped in and said “NO”.If the Chairman of the Fed cannot understand an investment or it cannot be explained with a single 3 x 5 card, then the SEC should be saying NO.There is a huge correlation with the recent health care legislation.

      1. JLM

        I am not a true believer but I do admit to taking more than a passing interest in what he has to say. I am awaiting his next book which is to be out shortly.This Christmas everybody is getting a book.

        1. William Mougayar

          Re: “This Christmas everybody is getting a book”, you meant “This Christmas everybody is getting or downloading a book”? I wonder if one can buy a Kindle download code as a gift. That would be the smallest form of a digital gift. Here’s your gift on a fortune cookie piece of paper: q334XCC88030 !

          1. JLM

            Haha, yes, exactly. Well played!

          2. RichardF

            that would be awesome

          3. Donna Brewington White


    1. Aaron Klein

      Now, now, even though I’ve left that decade, I’m not sure we can lay this at the feet of the 20-somethings. :)Your analysis is spot-on, as usual, though…

      1. JLM

        I am a huge admirer of 20-somethings. I just hired a bunch of West Point MBA types. They are the best. The very best. They are raw material thrown into the maw of their new found industry and will only be as successful as the old guys let and help them to be.But like every strong force, you must provide a bit of guidance. Leadership.Funny thing about life — 60-year old guys disagree and settle their differences with the blood of 20-somethings. That’s called war.60-year old greedy guys have an idea — like turning chicken excrement into chicken salad by securitization — and create their vision through the sweat of 20-somethings. That’s called Wall Street.The whole problem is the premise. The 20-somethings are just the muscle.You cannot take an inferior security — subprime loans — and turn a portion of it into an investment grade security by aggregating the cash flow in a disproportionate allocation.You cannot create a derivative security which by its very subdivision makes it impossible to collect upon the collateral and you cannot sell it to folks who do not know how to collect on a bad loan.

        1. Aaron Klein

          Well put.

    2. fredwilson

      restraint is going to be my mantra

  8. Adrian Bye

    thanks a lot for choosing to share this information.

  9. Robert Hacker

    Regrettably in the more esoteric investments (hedge funds, derivatives and venture capital) it may be the case that most investors do not understand the investments or do not know how to hedge the risk. Hedging the risk was obviously missing in CDO market.Influx of money looking for venture deals may just be a portfolio re-allocation based on the lack of attractive alternatives but understanding the investment is still the most important point. You might also point out that VC returns are based on mark to market and not necessarily cash realized returns.Passing on exceptional returns where the investment can not be understood is almost always a good rule. Madoff taught us that.

  10. Mark Zohar

    In addition to new investors trying to catch and ride the perceived (and mostly unrealized) growing returns of venture capital, I think what you’re also witnessing is the cult of celebrity taking hold. VC or angel investing used to be about long-term value generation (boring) and entrepreneurial backing (hard work) and, for the most part it remains so. However, it seems that some new investors are flocking into the space with the primary goal of being perceived as a “playa”, treating their investments like trophy kills and looking for a fast, easy flip. At the same time, we’re seeing more celebrities like Ashton Kutcher and Justin Timberlake in seed round deals. Who wouldn’t want to rub shoulders with these celebrities and gain similar insider status by funding the latest geo-social cross-platform mobile photo-sharing app?When VC and angel investing starts being perceived as bling to be waved around at dinner parties rather than a relatively boring and risky long-term financial investment, you know we’re in for trouble. I, for one, am hoping for boring to win out over bling so we can get back to the business of real business.

    1. fredwilson

      i agree

    2. JLM

      The celebrity investor angle is not a new phenomenon in the investment world. They were all over the tall building ground breaking/grand opening/landmark creating aspects of real estate development.Wayne Rogers represented a bevy of investors looking for signature deals in the 1980s.These celebs are almost completely unable to pull the trigger in the real world and though they have considerable personal wealth, they are a non-entity when dealing with real institutions.It is however fun to meet them and realize how poorly educated most of them are. Truth be known, they are mostly into banging cocktail waitresses.

    3. ShanaC

      Honestly, Me. If I could, even though they are getting some high priced and apparently important deals, it may be a sign of feature as a product. I would want to know the person is comptent at looking at a deal if I were in a deal. Except of some rare occasions (I probably would judge someone like William Shatner favoribly in a deal about dentists, as he was a dentist and is/was supposed to inherit the Listerine fortune, or Julia Louis-Dreyfus, if she had spent time ever on one of her family’s boards. or even an actor who had family working in, say, shoes which she learned about and now wants to invest in similar deals), I probably would look down and say “What do you know about this field and why are you investing in it?”

  11. John Prendergast

    Seems to me that entrepreneurs also need to observe, pay attention and be cautious raising money in this environment. Dumb money, overblown valuations, believing an idea is ready before it is based on funding success are all real dangers to companies that might otherwise mature into strong businesses.Don’t get me wrong, I think the current environment favors entrepreneurs. Its just that if you put jet fuel in a Smart Car just because you can, you’re more likely to blowup than get to the moon.

    1. fredwilson

      what a great last line!

      1. John Prendergast

        Inspired Matt. I think you’re still more likely to blow up than take off but you’ll do it in style!

    2. William Mougayar

      Yup. Speaking as an entrepreneur, the amount of money (or fuel) you take has nothing to do with your ability to be successful (beyond a reasonable level of course), even if they tell you naively: “if you take more, can you do more?”Suppose you need $2 Million, but they want to give you $5M at a higher valuation, you’re setting yourself up for a bigger fall if things don’t work out. And even if things work out, you’ll return a lower multiple to your investors than if you took $2 Million at a lower valuation, assuming similar exits and objectives for both situations.

      1. John Prendergast

        William, as an entrepreneur myself I can’t agree that money has nothing to do with your ability to be successful. The amount of money you take and who you take it from opens some options and closes others off. In the case of your $5M example it makes a smallish but potentially profitable exit far less likely. It also puts scaling expectations on a business which may still need to pivot its way to product market fit. It seems to me that in a startup your ability to be successful is highly dependent on the options you have or can create and if money impacts that, it impacts success.

        1. William Mougayar

          John,- the key part of my statement was “beyond a reasonable level”. If your business needs $5M, then by all means take the $5M and scale it. But my point is if you need $5M and someone wants to offer you $8M and inflate your valuation along the way, then it’s not good.And to clarify things further, I’m not assuming that this is the last round. Chances are that the VC who will give me $2M now will be around to give me another $3M when we meet our milestones, versus the one that will give me $5M on an inflated valuation who will be out of breath (or money) in a year or so.

        2. JLM

          There is an opportunity to create a “funding basket” which provides for you to draw funds under a certain formula and only be tasked to account for what you actually need and use.I am always in favor of getting as much money as you can but I understand the long term implications of the “rent” on the money.

    3. BenjaminDWalker

      Remember that time when the resulting thread focused more on the metaphor rather than your original point. haha Good times, Good times!I enjoyed your original comment; for what it is worth. Good day sir!

  12. Kate Huyett

    One thing that has been omitted from this post and comments so far is the role of the ratings agencies – a sharp differentiator between what went on in the markets described here an the VC market. Many investors assumed they could trust a third party to do their diligence; but the ratings agencies were chasing their own “returns” in the form of high fees. The agencies helped fuel the bubble when they should have been its brakes. From the story about a few investors who have approached Fred described in the post, it seems like many of the people chasing returns are using VC or angel signaling as a proxy for ratings and an excuse to forgo diligence. One of the things that makes me believe this bubble(?) will not get too overblown is that there are many top tier VCs and angels sounding warnings rather than fueling the bubble.

    1. LIAD

      Great point

    2. JLM

      Brilliant comment. The rating agencies are the ugly girls at the dance who were the Prom Queen for a night and in return pulled a train for the entire football and basketball teams.

      1. Kate Huyett

        Great analogy.

    3. fredwilson

      i sure hope so

  13. Tariq

    Just wanted to chime in and say that Too Big to Fail was my favorite book on the crisis — it’s just a great study of decision making under pressure.I think that when you have an influx of new capital into a market you invest in, it always makes things a bit more difficult for the investors in that space. The biggest mistake I saw during the crisis, by investment funds, was an inability to go to cash/maintain discipline. Instead, they argued that maybe we were experiencing a new period which warranted higher valuations and they agreed to pay up. They didn’t give any thought to mean reversion, they just wanted to keep being active. And as a result, when the market tanked, some of these guys were down 60-70% for the year which is just terrible performance.

    1. fredwilson

      rightthat’s what is going on in my mind right nowi don’t want to stop investing but i know we need to be very careful right now

      1. Tariq

        I feel like just the fact that you had to live through the dot com bubble, especially in NYC, must really give you a leg up in a frothy market because you’ve seen what can go wrong when investors aren’t cautious.

    2. Kate Huyett

      I think much of the reluctance to go to cash was the result of investor pressure – people saying they would take their money elsewhere. Huge risk for fund managers is that they exercise restraint and underperform their peers versus keeping up during the updraft and being one of many to do poorly. Standing alone is always scary, and the more liquidity a given fund provides to investors the less willing they will be to take the risk of differentiation and be forced to sustain captal outflows.

      1. Tariq

        That’s true – I had a meeting a few months ago with a large fund and they mentioned in passing that they have to keep their cash allocation very low because that’s what their consultants push for.I think that is another side of the equation, when you run a fund you really need to cultivate the right group of investors — the kinds of people that will allow you to sit out frothy/bubble periods. Because if you don’t, you’ll end up having your assets walk out the door.

    3. Fernando Gutierrez

      Asking a fund manager to stay cash is like asking a plastic surgeon to tell his patients they are already beautiful.

    4. John Prendergast

      Very few fund managers have the stomach to go to cash when they should. In fact, Seth Klarman is the only one who comes to mind that manages to do it consistently. I’d love to know about any others with that sort of discipline.

      1. Tariq

        Seth Klarman is definitely the best example. That guy will go 50% cash when he gets worried and in general, it seems to really pay off. After all, he’s managing over $20B now!But there are others out there, especially when you hit the smaller end of the market (think 100-200M in AUM). Most of these fund managers were value investors that focused mostly on special situations/event driven investments, who also paid attention to the macro. So overall, they were looking for investments that were much less correlated to the broader market.Still, there were plenty of long-only value guys that ignored the macro and took a very ultra-concentrated approach (5-10 portfolio positions). Some of these guys were really just operating as ultra concentrated versions of the S&P which is why they took 60-70% hits that year. L/S investors faced the same issue, even though they called themselves L/S, at the time, most were net long the market. So I think it takes a constant paranoia and discipline to always look at overall market valuations to see how much cash/long/short you should be.

  14. Dan Frommer

    Interesting stuff. Here’s my question: Are you reading this (massive) book in paper format? Or on a Kindle? Or iBooks on iPad? Just curious.

    1. fredwilson


  15. Druce

    History repeats itself, as Hegel said, prompting Marx to add: the first time as tragedy, the second as farce.All that QE money has to go somewhere… 2.8% Treasurys for 10 years? If this is a bubble, we might still be in the 6th inning – still cheap stocks out there, things haven’t got really crazy yet, but they probably will, the question is where – social/mobile/cloud is as good an excuse as any.Some of these stocks yield more than Treasurys, have reasonably safe dividends, possible room for growth.

  16. MassMan

    The mobile revolution represents the greatest paradigm shift in media consumption since the emergence of the web. And yes, there will be blood.Hold on to your returns…it’s going to get pretty darn exciting around here.MassMan

  17. howardlindzon

    was parallell writing on my blog ‘Monthly Returns – The Chase is On’ so thanks for the quote.… that same money is poouring into our new nifty 12

    1. fredwilson

      just left you a comment on your monthly returns post

  18. Scott Barnett

    From what I’ve read, it seems there is one other detail, particularly around the mortgage fiasco – and that is they were illegal (or at least improper). Many of these mortgages do not have the proper paperwork that show proper transfer from one entity to another – as they were getting rolled up and re-sold as more complicated investment vehicles. So, not only were people chasing returns in an area they didn’t understand, they were bending and twisting the rules (and many times breaking them) for their own benefit.We have become such a lazy country – looking for “quick” wins – which allows us to look the other way as people take short cuts and break rules to provide an illusion of success. So, while I totally agree with the idea of not investing in something I do not understand, I also look at the “too good to be true” aspect of an investment – because I don’t believe that exists. It may be old fashioned and boring, but I’ll take the slow and steady ride to the top any day, because I can’t think of a single example of a sustained success that got there quickly.The problem is, how many people don’t agree with this sentiment? Until that changes, I don’t think we’ll see a change in how the market dysfunctions.

  19. andrewdeandrade

    If the quantity of money in the market is this good, I would hope that entrepreneurs start pushing from really good terms from those that don’t understand their market and won’t be bringing good advice. i.e.investors who understand my startup’s market and can help – these guys get preferred shares and a board seat.investors who don’t understand my startup’s market and can’t help – these guys get common shares and no say in how the business is run. they are just along for the ride.I think this puts us in the right direction as it starts to place a value on money and doesn’t treat all money as equal just like all startup ideas, teams and execution are equal. Investment money in this market has a value proportional to the value the investors bring. A smart investor brings more value with each dollar they invest. e.g. one of their “smart” dollars may be worth two “stupid” dollars.Right now the only people looking at the returns of funds are limited partners. It would be interesting if the other side of the market (i.e. startups raising money) now start valuing and discussing the dollars they are receiving.

  20. Dan Ramsden

    I think there is an important difference between the two bubbles described, in terms of liquidity and amounts invested, that shifts the concern from one of financial system volatility to something different, that is more personal in nature.(a) Venture capital is probably a smaller portion of LP’s portfolios today than structured finance vehicles may have been a few years back, (b) venture capital is a private market in which values are not reset every minute, but are marked to market in ways more artistic than scientific, and (c) LPs don’t rely on immediate liquidity realization in venture capital and consider their portfolio durations accordingly. As a result, it isn’t a big leap for LPs to shift small portions of their assets into the field (in order to “chase yield”), and the downside of this particular bubble is not overwhelming financially.For entrepreneurs, however, as a whole, there is serious risk… because they constitute the raw material, the pipeline that now has to be filled. And I am concerned, for example, about the glamorizing of entrepreneurship that I often encounter, which may have the effect of encouraging people who are better suited for other options, other ways to make a living and be happy, to embark upon an enormously high-risk personal path.In other words, the systemic risk of this current bubble is not so much financial as one that may impact the entrepreneurial class overall. The majority of startups fail, which is not the end of the world in a diversified financial portfolio.

  21. Evan


  22. JordanCooper_NYC

    nice post. to be fair, you’ve been doing this for 15 years, and I would be absolutely shocked if you haven’t encountered investors chasing deals they didn’t understand in each of those 15 years. Granted, I’ve only been doing this for 5 years, but there has always been dumb money in the market, maybe just not as much. Think about that list of 5 guys you call when you need to get a portco funded, and the story isn’t obvious. You know, the guy who just wants to get into a deal w Fred…that guy makes the bet for all the wrong reasons, but he has been around forever, and will continue to be around for ever.

    1. fredwilson

      that guy scares mei don’t want to be anywhere near him or her

  23. William Mougayar

    In 1996/97 we all saw the Internet mountain. The wise ones (me included, and i wrote a book to prove it “Opening Digital Markets” published in 1997) said- It might take 7 years to reach that mountain. Then the late comers or over-zealous folks came along in 1999 and said “No, let’s reach that mountain in 1 year”.We all know how that story ended. Speed kills.

  24. Michael Griffiths

    Good point.I think it’s important to realize that chasing returns is *by definition* bubble-inducing. Conventional economics assumes that people invest in fundamentals – that is, they invest in the accurate (risk-adjusted) forecast of company revenue/profit/returns; not the social hallucination.Or: the idea that the stock market/investors accurately value a company is based on the assumption that they are *not* “chasing returns.” As soon as people start to, valuations diverge from reality; at some point, they have to return to reality.It’s an interesting problem, because there’s a finite amount of money. That is, if investors are chasing returns in one segment – inflating the valuations of companies ‘above reality’ – then other segments are by definition under-valued. The question is identifying which ones are under-valued, and how long it’ll take before they ‘return to reality.’ Thus, there’s opportunity when people chase returns.Not practical for an individual, though, as an entire sector (like “VC capital” or “Angel investing”) can become over-valued, and other sectors entirely can be under-valued. But for distinctions like “social” and “enterprise,” it’s useful.

    1. fredwilson

      that’s one of the many reasons i like the idea of being contrarian when investing

  25. Lewis Gersh

    Too big to fail makes as much sense as too fat to diet.

    1. JLM

      Nonetheless, understand that the guys in DC and on Wall Street have used this rationale to make huge investments of OUR money and important policy decisions.The UAW — effectively a PAC based upon its conduct — will reap a financial bonanza of gargantuan proportions because they were anointed a “winner” in the financial sweepstakes which was the GM bankruptcy.The government gave them a huge slice of the new GM equity.The UAW and its unquenchable thirst for compensation and benefits was one of the causes of the failure of GM.Did you also know that the Administration has allowed — contrary to settled law pertinent to bankruptcies — the “new” GM to receive the $45B NOL (net operating loss) carry forward pertaining to the “old” GM.That means that the new GM can avoid taxes on the next $45B of profit at a 35% rate!Is that fair?Why was this necessary? <<< to ensure that the new GM would be successful. How would you like to have to pay taxes when your competitor down the street does not?Of course, they will be coming to you for the difference.The government needs to have its thumbs amputated as the only possible solution to getting their thumbs off the scale in every public policy issue they stick their noses into.

      1. Aaron Klein

        I especially appreciated when they spent my money to thank me for helping them “get back up” during the Macy’s Thanksgiving Day Parade.As if I had a choice.

  26. Tom Labus

    There was a standard respond by each CEO of a beleaguered bank: Stop the short sales. I realize this is part of the market working but there has never been (or I haven’t seen it) a good analysis of just who was short LEH etc.This is playing out again with the Euro debt crisis eight now.

    1. JLM

      Stock Exchanges were created to provide a marketplace in which the shareholders of member companies could meet to auction or otherwise sell their shares to like minded investors.The Stock Exchanges required Transfer Agents to effect the exchanges and to run the books of the member companies and the shareholders.Brokerage firms held the shares in accounts for the individual shareholders who held their shares indirectly in “street name” accounts.What the founders — the companies who issued the stock in the first place — of these Stock Exchanges did not anticipate is the Stock Exchanges being used as a gambling casino, in effect trading shares that sellers did not actually own.Oh, sure, the brokerage companies put a bit of perfume on this turd by pretending to “lend” shares to those who did not actually own them.Even this fiction did not last very long as it became possible to trade “naked” without even the fiction of borrowing the shares.Bottom line — companies did not found the Stock Exchanges to run a casino with their shares as the chips.Short sales always “deepen” the down and they always dampen the stock’s chances of a recovery. Short sales are not the actions of the shareholders — they already own the stock.

      1. Tom Labus

        There could be pools of capital controlled by foreign intelligence services that were (are) used to disrupt the US economy.

      2. Dave W Baldwin

        add in the technology that tracks activity and buys/sells at the incredible rate of speed based off of what is tracked…some have this tracking tool right outside the pit.

  27. daryn

    Fred – How much do you think individual investors really need to understand? I think at a high level you need to know what is going on, but the details and potentially complex economics are why you invest in funds and have advisers and money managers. Reputation and trust go a long way; the individual who wanted to invest in your portfolio company probably saw something exciting with smart investors behind it, and wanted to be part of that.

    1. LECHSAM group

      Daryn- I wholly agree about reputation BUT knowing what is going on is the basis on which to do your research – due diligence – to get a better understanding of the potentially complex economics. Leaving the complexities to a fund manager can turn out to be a case of the blind leading the blind.What if a fund investing in web services are becoming too heavy in investments that do not scale well… unless you have a working understanding of the space, you can very well not see the fund is going to implode until it is too late.Prudence is one of the pillars of good investing, regardless of dollar size. It is said that if it is too good to be true, it probably is… well, without a knowledge of what you are getting into, you cannot gauge what may be too good to be true and we all know what worms sit in that can!

      1. daryn

        Well put, and I agree that the more understanding you have, the better.My only point is that having faith in someone you believe in, say USV,and following their lead (or investing via something like Covestor)isn’t exactly the blind leading the blind. If I understand 90% oftheir deals, and they are aligned with my interests, then I wouldprobably be willing to ride along on the other 10% as well.

    2. fredwilson

      i get the idea of wanting to invest in our funds. but they also wanted to invest in our deals

      1. Alex Murphy

        Investing in USV is a specific deal. It is easy to understand.- NY Firm- “Small pond” with a lot of start ups to look at that meet a unique criteria, low cost to start, large customer base locally, diverse talents to build unique products that serve the broader market- small group of decision makers with decades of market specific experience- history of making it happenThat is an easy decision … USV is a no brainer as an LP.Four Square, if you are a Prince from XXX Persian Gulf country … I don’t think that there is a huge demand for checking into Buckingham Palace and as such I don’t think 4SQ would be something they would understand and thus they shouldn’t invest in; nor twitter, nor zynga, nor getglue, nor indeed.

      2. LECHSAM group

        Hmm… Given this new bit of information it seems they wanted to have the cake and snatch the recipe and baking instructions while in the kitchen.

    3. JLM

      Investing in Peter Lynch’s Magellan Fund was an investment in Peter Lynch — not a bad bet. The fact that Fidelity owned them both was not so important.So, I agree w/ you. Completely.

  28. Steve Hallock

    Loved TBTF.I tend to view us as much further towards the beginning of the hill than many others. As articulated so beautifully by Steve Blank last week, we have reached the perfect storm of a new technological revolution (mobile web, web services, and continuing with the webbification of everything) mixed with tools that dramatically reduce barriers to entry for entrepreneurs. The potential here is so huge that I think the general trend will be up for quite a while.I happen to be currently working in an industry (luxury goods) that has just barely begun to be touched by new technology and new consumer patterns. I go through every day both at work and at home seeing things that I know will be drastically improved soon. We have already seen the world become much more efficient and there is a long way to go.Of course, some stupid money will flow in from people who also have that feeling but may or may not be able to articulate it. While the tide rises, some ships will sink. Those people will have a much higher chance of being in a sinking ship than a USV or other person/firm that knows what they are doing and has access to better deals. Of course the stupid money will also reduce overall returns as initial costs will be pushed up. But the important thing is that the world is going to change drastically for the better and there is still a lot of money to be made in helping that happen.

    1. Moses

      I loved the Blank piece as much as anyone, but when a bubble forms there is always someone out there who comes up with a theory to justify it. The wording is usually “this time it’s different”. And it’s never different.

      1. Donna Brewington White

        …something to think about.

      2. fredwilson

        Its never that different in the long run. We all die. All booms bust. Changeis constant

    2. Dave W Baldwin

      The reason Blank’s piece holds is the ‘dot bubble’ really was not that long ago. Those in their 40’s/50’s know what happened.No matter the cycle, the con men will be there and dumb money to follow in all shapes and spreads (including Gov.).Since more of the population is beginning to understand what we can do this decade, there will be more outlook going long…which is good. The real problem is ‘get rich quick’, but that has always been there. Over the next two years, some surprises will occur and then we’ll have better lead dogs the other dogs will follow.Patience.

  29. Venkat

    Fred:What do you mean by “understand a deal”? From the usual conversations in entrepreneurial/VC blogs, it seems the 3 things to understand are people, process and product (i.e. great people, preferably following a process like ‘lean startup’, and product that makes a zeroth-order sense as a good starting point for iteration and pivoting towards an attractive market).Which part are the ‘crazy’ investors missing?And do they really NEED to get it? Isn’t the whole point of the invest-by-imitation social proof model the saving of individual due diligence costs by piggybacking on the decisions of others? In the past you’ve said yourself that VCs do it too, which is why you get bandwagon effects. And it seems the super-angel consortiums also operate by a social proof domino effect too. One investor does most of the thinking, the others follow.Or is your concern with the social proof foundations? (I don’t like it personally, but I can’t see how investors can cost effectively understand the huge number of available opportunities without relying on social proof…)Venkat

    1. fredwilson

      first of all, i don’t think you’ve ever seen me write anything in favor of “social proof”. if i have, i must have been momentarily insane. social proof is idiotic. following others is idiotic. if you don’t understand it, don’t invest in it.second, there are hundreds of things you need to understand to invest intelligently in early stage VC. people and product are two of them. but there’s the always important business model. how much capital it will take to reach sustainability. how much dilution and liq pref will be added along the way. what changes will be necessary. etc. etc. etc.i’ve been at it 25 years and i am just beginning to think i understand this business. it is not a good place for novices.

      1. Venkat

        I may be mistaken. I couldn’t find the post with a brief search. You didn’t use the phrase, but what I recall is a post you did where you explained why certain bandwagon trends emerge (i.e. one VC firm getting a ‘hit’ with say a “mobile check-in” startup gets every other VC hurrying to find and fund their own “mobile check-in” startup because the first firm is presumably on to something). I don’t recall whether or not you condoned that type of thinking.It isn’t “tight” social proof like investor-domino effects in a single round, but a weaker kind of flocking to a sector thought to be a ‘hot’ on the basis of an early success.But thanks for hinting at the “100s of things” … at some point, I’d enjoy seeing a post on the major sights along the VC learning curve. Perhaps a topic on MBA Mondays… you’ve mostly written it for entrepreneurs so far, but perhaps at least a vicarious glimpse of the investor education path.

        1. fredwilson

          if there is anything i hate more than social proof it is copycat investingi absolutely hate it with a passion

          1. Alex Murphy

            Here’s to the lemmings of the world … may they all fall off a cliff. 🙂

          2. Michael Kogan

            isn’t this what your portfolio company covestor offering ? 🙂

          3. fredwilson

            No. They offer people like you and me the ability to invest capital inemerging new managers. I am with three such managers in my covestor accountand blogged about one of them a while back

          4. Venkat

            Not to go down a rabbit trail, but copycats are acquiring a new-found respectability at least in business models if not investing. See Oded Shenkar’s recent book “Copycats” which I reviewed here:…I was impressed. Possibly the arguments apply to investing as well.

          5. fredwilson

            I have a bit more respect for copycatting when it comes to business models

  30. lushfun

    I am hopeful that this is just the beginning of the insanity.Market will most likely over saturate with investors and most of those whom understand valuations within the market like Fred will be pushed, albeit so slightly to the sidelines.As fools rush in it will be opportune for anyone with crazy ides to get funded, providedthe ideas are crazy enough.I am still struggling myself to come up with one that’s completely insane. Perhaps a social network that’s written in oxygen molecules so that you could talk to your friends as you breath in and out permeated with pheromone advertising. ZipGirl ? or ZipBoy? where you can rent a girl or boy for an hour? lol jking ofcourse

    1. fredwilson

      i’m not going to the sidelines

  31. Sandra | Get Relationship Back

    Seems like our economy is constantly in a state of bubbles – things are undervalued and grow, and people see (or chase) the returns…eventually everyone wants in even though the intrinsic value is way overinflated. I see bubbles right now in VC, Green Tech, and Startup schools (like Ycombinator). All of these industries are in the “chasing returns” period – where valuation isn’t necessarily worth the risk/investment. Eventually there will be an adjustment in all of these.

  32. William Mougayar

    Re: Foreign investors into AVC’s fund, from Taleb’s new upcoming book “The Bed of Procrustes”: “You are rich if and only if money you refuse tastes better than money you accept.”

  33. R.S.Carlson, DDS

    The reason Alan G did not understand CDOs, nor his crony PhDs (Phony Dopes), is that the mathematics did not exist, for they were fabrications. The whole presentation was a lie. The banks really never “woke up,” but their dead bodies were rolled over and the FED Boyz keep rolling them down the hill. As I believe you noted so well Mr. Wilson, links are the new currency. The current currency is paper, has no value but for what a paper might bring in “appreciation” or “gratitude.” Actually, paper or metal money is not more that votes of appreciation/gratitude for a service and you provide a vital service connecting those who wish a new way of thinking, a World View of workability among entrepreneurs. PS I just met a fellow on his way to SF who put me on to your and your work. I do dental fixed bridges without cutting teeth at 1/2 the nominal costs, 1/5th the time, and have them fly to Honolulu for the “fix.” Google carlsonbridge. Dr. Carlson Aloha…Dr.Carlson

  34. vruz

    What happens when an entrepreneur gets a sweet deal, too sweet to let it pass, and you’re on board on the same boat with these investors and their displays of exhuberance?

    1. fredwilson

      we try to keep everyone cognizant of the risks

  35. Mark Essel

    It’s an extraordinary time to witness new companies come to life. Two man operations on KickStarter are blooming into real revenue companies.What you have eloquently identified is demand without sufficient supply. In this case the supply is a limited number of entrepreneurs building companies that can provide sufficient returns. It’s clear that the market demands a greater number of viable startups. Current business models aren’t providing fertile investment soil for risk capital.Startup ecosystems have sufficient capital interest, but they don’t yet have enough of extra-capital resources (mentorship, business networks, cheap working space) to expand beyond a dozen or so city hubs. In one limited case, each time I search locally for hints of startups communities on Long Island, I find a trail of founders that get sucked into Manahattan for better odds of connecting with support systems.

  36. Gary Sharma

    On the other hand there are times when everyone is overly pessimistic and doubling down on their current investments and not taking enough risk and investing in new companies when they should be. So I guess maybe things even out in the long run.

    1. ShanaC

      Gary sometimes I think that’s the healthiest attitude of all.

  37. csertoglu

    The outsize returns through complex structures come in two flavors: brilliant thinking and brilliant scheming. I think one way to avoid the second kind is through some insurance structure, where an underwriter needs to understand the model. I think this would have prevented enrons and madoffs.

    1. JLM

      Enron wandered off the game board, Madoff jumped off a bridge.You can nudge the Enrons back on to the game board if the regulatory forces are niimble enough and if Boards of Directors are willing to play their rightful role. You can catch them just as their crayons cross the edge of the coloring board.You cannot rehabilitate the Madoffs of the world as they are already criminals in their hearts. They started out as criminals and knew what they were doing.Funny thing about the Madoff scam is that a couple of very smart folks saw that the returns were so mathematically unlikely as to be impossible.The SEC chose not to listen. Proving the theorem that the SEC enforces regulations in inverse proprotion to the quality of your tailor.

  38. ShanaC

    I just finished that book- honestly one of the most striking things about the book was how regulations don’t keep up with innovations in the market at all, mostly because the most innovative people are rarely the regulators. I keep thinking in some ways that chasing yields without understand how innovation works toi create those yields is what causes those risks to happen.Kind of reminded me of a lot of FCC issues actually. They’re trying to regulate around a risk they don’t quiet understand because a lot of people keep innovating around it.

  39. andyidsinga

    I like your statements:”Venture capital is not financial engineering”.and “It is about making an investment to turn nothing into something. “When I read the bloomberg article you linked to – it was worrisome.Fred / anyone – Are there any protections in those secondary markets for investors? What happens if those secondary markets start becoming common place for “hot companies” that much less mature than facebook other than the “opportunity to sell for employees”?

    1. ShanaC

      I’m less worried by the derivatives than the derivatives being used to chase a yield rather than what they are really meant for -hedging risks. OTOH, I keep thinking that second market will need to bend to derivatives, as there are enough people out there who will want to hedge the risk of what they trade way out there.

      1. andyidsinga

        Is the thing they are selling on the secondary market made up of stock of several companies or just one? ..or it can be both?If it was made of several companies, some being less risky, that would be where the hedging risks comes in right?Thanks :)(edit: I apologize in advance for butchering the varoius terms please correct me etc)

        1. ShanaC

          so Second Market has a lot of things they exchange (you can see a list here: In the case of FB, they are selling fb stock back and forth directly. The derivative that they are talking about in this case seems to be a prediction of how facebook shares will move in the secondary market, based on grouping a lot of shares together that someone bought in a fund. the underlying value of the derivative is the movement of Facebook Shares as a whole.So if I were a Facebook investor and had some secret concerns, it would make sense to buy into this fund’s derivative because its a hedge on that concern. In the case of a lot of other people, there are a number who just want to speculate- and it seems to be the majority right now.(off topic -who is betting against this derivative, you need a partner, because that person(s) have got to be interesting.Also off topic: please don’t ask how I figured this out.)

    2. fredwilson

      i think you can expect the SEC to step in and start regulating those markets

  40. Kris

    A bubble like 2008 , but in the VC market. Imagine this scenario:There’s a lot of money coming to this market. And we all know there aren’t enough Fred Wilsons in this world to invest $ 10 billion in start-ups.No need to worry. I have a solution. I made 35% on my investments last year. I can do it.Cost : $ 10 million / year to manage $ 10 billion. Duration : 5 years Return : Likely to be 35% a yeara.k.a. a very good deal !The first thing those Foreign Investment Vehicles will say is “Wait a minute, and what happens when you lose our money?”For every problem, there’s a solution, guys. I’m giving you the chance to buy VC Default Swaps.It’s like an insurance policy. You will never lose your money. You always get it all back.This insurance policy costs $ 100 million a year That’s less than 1% !! It’s bullet proof and there’s a chance of making 35% a year. It’s an amazing deal !”Alright, we’re in!”Year 4 : I’m crushing it, guys !Valuations are skyhigh.My income so far : $ 440 millionNote : I decide to sell my VC Default Swaps on the derivatives market. Fred who couldn’t get any deals anymore decides to buy my VC Default Swaps.He buys them for $ 200 million. In 2 years time he will have doubled his money.I won’t be making $ 100 million in year 5 , but that’s ok.I already made $ 640 million(4 x $ 10 million) + (4 x $ 100 million) + Fred’s $ 200 millionYear 5 :The market crashes.Don’t worry, guys, you’re all gonna get your money back. Just ask Fred.

  41. Kris

    Warren Buffett in his 10K : Those derivatives are weapons of mass destruction.I remember reading that 10K a bit less than 10 years ago. Years before the crisis of 2008 took place.Buffett knew about the risks, the CEOs knew, and Greenspan knew it as well. So when I see Greenspan’s comments about how he didn’t understand it, my blood begins to boil. He knew exactly what was going on. He shouldn’t be making excuses, acting like he didn’t understand, when he had access to all the data!Before he quit his job in 2006, he was the one fueling the real estate bubble by lowering the interest rates. 2 years later, the bubble crashes. He didn’t understand it? Give me a break!!The CEOs knew it as well but it didn’t matter. Their goal was to take the money for as long as they could.What they didn’t understand was how to manage the risks being taken. The risks of the real estate bubble were lurking around every corner, all over the country.I don’t think that’s what’s happening righ now. But it could when there’s a market for it.Fred, your blogpost tells me it looks like those foreign investment vehicles do understand.They seem to understand the risk.They’re looking for someone who knows how to manage the risk for them.If you could do that, and you know how to scale it, then there will be no need for the investment vehicles to take risks they can’t manage.No matter how you slice it, with no shortage of money in sight, and the internet rapidly breaking down all walls, VCs are in for a lot of competition.In a few years time, how will the entrepreneurs separate the wheat from the chaff when everyone’s making promises?It keeps bringing me back to the incubator model. There’s a team, there’s support, and it scales.Maybe not yet on a global basis but it works.Again, if you could do that, with more money ..It won’t stop the bubble from getting bigger though. Maybe not as big as in 2008… maybe someone ought to start a market where we can all easily trade Facebook stock. Perhaps do so without having to pay a dollar. (as buying FB stock naked) And why stop there. Derivative products like VC Default Swaps sound interesting. See my previous post.

    1. fredwilson

      i don’t know how to scale itin fact, i am pretty sure VC doesn’t scale

      1. AlanP

        Well, firstly we now have to manufacture more entrepreneurs, so I can predict the rise of:- “The Entrepereneur as Social Hero” narratives, fueled by New First Tuesdays, Wednesdays and whatever other days one can get.- More Incubators, churning out more copycat businesses for these nvestors to buy- More Entrepreneur Porn for PR puff to do its thing – all those dotcom magazines, websites, etc. When Red Herring is re-founded you know the thing is flying.Secondly, we need to manufacture more types of businesses to be invested in, as teh small subset of sensible ones plus their 10 clones are not enough, so expect a new round of oppotunities to invest in hard-to-work-out-what-they-do companies “for carrying out an undertaking of great advantage, but nobody to know what it is”Thirdly, new market research has to show that the market is waaaay bigger than any fusty old last-years-analysts thought, and in fact these new technologies open a new economic paradigm.Methinks Ms Meekers move is mayhap part of all this…..

  42. ninakix

    What about founders: can we expect a fair amount of fatigue on the part of consumers who see all these products and get totally overwhelmed?

    1. RichardF

      that’s a good test for your product nina. Sorts the wheat from the chaff.

    2. Tereza

      I’d say go after consumers who’ve been ignored. There are plenty of those. 🙂

  43. ShanaC

    Also a question for me when thinking about chasing risk- how much of this is being compounded by the media(s)? Something I remember from that period is Mortgages on TV. Now I see startups and websites on TV.

  44. Ruslan Vasylev

    The more they try to manage and stabilize the markets, the more they hinder markets’ abilities to stabilize themselves and sort good investments from bad ones. :S

  45. JackS

    Blame Tech Crunch for spreading the belief that everybody gets rich doing it. and any idiot can do it.

  46. Markus Frind

    I don’t see what the problem is… Sure a bunch of red hot startups which grow extremely fast can now command huge premiums. Its not like 2000 where everything that got funded tended to go out of business. Name we one hot consumer facing web company of the past few years that had massive growth got lots of funding and has gone under?So in short the risk of a company with a huge growth rate going out of business has dramatically declined. Because of this decline in risk people are willing to pay higher amounts. It only gets scary when companies with marginal growth and prospects get funding at a massive premium.

    1. fredwilson

      and you expect everyone getting funded to stay in business this time?

      1. Markus frind

        Not everyone but a lot more than last time around in 2000.Lower risk = higher prices. I think deals for fast growing companies will command more of a premium as the probability of failing is lower.Its not like every dog out there is getting funded. Than again i’m not in the valley and here in vancouver not much of anything gets funded even at the best of times.

  47. Alex Martsenyuk

    I think investment banks (and as we found out after the crisis the regular banks too) have completely embraced the role of money-making machines rather than support and capital distribution system for businesses. Hedge-funds lead the game here, pretty much trailing the market returns in good years and doing many times better when market returns are negative. The excess leverage is one of the first thing that comes to mind that is used strictly as a direct returns booster and has little to do with aiding the businesses grow or the economy function more efficiently. From what Fred is saying it seems that a lot of venture investors are on this this path too, only seeing the end % of returns and trying to influence it directly and as fast as possible. As the industry becomes more liquid and easier to access there will be bubbles springing up every time a major money making trend occurs (like “social” with facebook skyrocketing).There needs to be a constant effort in reminding to the financial services industry of its role in the bigger scope of things – the role of the support for business and economy operation rather than money-making any way possible. So far bubbles has served as such reminder, but most recent Fed money-spraying efforts seem to make this mechanism less irrelevant.

  48. songseets

    Oh wow, OK that really does make a LOT of sense

  49. Bala

    You are a wise man Fred!

  50. paramendra

    Why is investing in something Fred Wilson has invested in a bad idea? What is there to understand? :-)Racism Caused Recession

  51. Geoff Morrissett

    That was/is an excellent book! Another great financial history book that I am slowly digesting is “This Time is Different” by Reinhart and Rogoff, who I had a chance to listen to approximately a year ago regarding the economic crises around the world and the role of debt in it.I saw your recent Web 2.0 interview with John Doerr regarding bubbles or booms in the current technology market, too. Perhaps it raises the question of intrinsic vs. perceived value? Despite its success, Facebook appears to be a good example of this extremism in valuation.I once shared with you an earlier top-down valuation model for VC-backed entrepreneurial firms that “outsiders” can use to orient themselves in understanding the performance of the firm in question based on expected returns to LPs. It has proven useful to me in grounding operational execution in the world of reasonably aggressive reality. I have used it to as an indirect input to budgeting, business modeling, and market planning because it helps characterize risk in quantitative terms. Understanding risk means understanding opportunity. That results in effective decision-making – by entrepreneurs and VCs alike.

  52. Richard Kain

    Is the phenomenon of not fully understanding what you’re investing in really different than most other asset classes? This might be unusual — to date — for venture investing, but in a perverse way that is a sign of the maturation of the asset class.The overwhelming majority of fund managers understand little of the unique attributes of any of their particular stock holdings. Grandma doesn’t know the relative merits of whatever Illinois Water authority bond her also-likely-ignorant advisor put her into.Is this prospective investor really chasing returns or just reading David Swensen and wanting to diversify like big boys? Might they not be chasing returns but portfolio allocation?Having said all this I appreciate the sentiment that too much liquidity, that a bubble, for all the short term munificence, might have corrosive longer term effects.

  53. Brian Broadbent, CFA

    I disagree with your Wall St. analogy but agree with your overall conclusion. The problem with the CDOs/CLOs was bad collateral (e.g. bad underlying assets), not bad structures that people did not understand. To create the assets to put into the CDOs, your underwrite bad loans that should have never been written in the first place. It was simple greed — too much money chasing too few deals — and nothing more. No different than the junk bond craze of the 1980s.If the sovereign wealth funds want to make big returns, they should fund LBOs of companies that can use social media to drive returns in their portfolio companies and not chase home run VC deals. If an LBO’d company can drive a hundred basis points of margin improvement and 100 basis points of top line growth from social media (I am completely making these numbers up), that would translate into big returns for their investors. There is a lot more cash to put to work under that scenario.My advice to Gotham is to talk to Goldentree Asset Management. They largely stayed on the sideline for years while the whole debt boom was going on and emerged stronger on the back-end. While it’s hard to turn away hundreds of millions of dollars at 2 and 20, it might be the best decision in the long-run.

  54. Mike McGrath

    Try Bob Pozen’s “Too Big to Save?” for views I think you will be aligned with. Its the cream of the crop for bailout books.

  55. James brown


  56. LissIsMore

    Too Big To Fail. Humbug! Who were the ones making that argument? The Bankers (with their Banker-in-Chief Hank Paulson). They did not understand what they were investing in – and we did not (and still don’t) understand what we were propping up when we bailed them out.I like the way Fred brought this back around to the VC world. This, too, can get frothy and bubbly. When dumb money comes pouring in (as in his sovereign fund story) it is time to be careful. The difference here is that the VC world does not have a safety net. Losses can, and will, be born by the investors.Fred, representing the Smart Money, may continue to see companies that interest him – but at valuations that scare him. As Warren Buffet is fond of saying: “Good companies at bad prices are bad investments”.

  57. Dan Sweet

    Fred, your recent experience with foreign investment vehicles reminds me on the anecdote in “Running Money” by Andy Kessler where in one week at the same table in Il Panino he is offered half a billion to manage by two separate SWFs. He turned them both down, went home and started selling cause the market had stopped making sense. He nailed the top of the market, btw. Understand VC is different and I get your philosophy on putting cash to work, just saying your experience may be an interesting macro tell.

    1. fredwilson

      not sure it is differenti’ve been walking away from investment opportunities right and lefti’m not shutting down but i am being very very careful right now

  58. Guest

    “It is about making an investment to turn nothing into something.”Seems as if one were to make an investment on nothing, he may be “chasing returns in deals [he doesn’t] fully understand.”

  59. John Prendergast

    Venture money most certainly is jet fuel, with angel funding, it depends. The issue is that if your business is venture appropriate, by all means, raise your capital.The problem is that normal markets help determine which deals are venture appropriate. Markets like this tend to fund deals that aren’t venture appropriate creating a bad situation for the entrepreneur and investor alike. In those deals the entrepreneur is almost always better off bootstrapping, funding with friends and family or angels with more modest expectations.Just an opinion.

  60. John Prendergast

    Couldn’t agree more.Milestones are just free options with a locked in price for investors. Get the money you need to hit a value inflection point and then some to allow for pivots. Of course this is assuming the business is right for venture funding in the first place.

  61. William Mougayar

    Agreed. I didn’t mean it so rigidly. (see response to John about same). Thanks.

  62. William Mougayar

    I hear you, and Charlie. I don’t like the rigidness of milestones. I meant it loosely- more like objectives or whatever levels both parties are satisfied with. Yes, I like value inflection points. The life of a start-up is all about going from one level to another.

  63. John Prendergast

    So if jet fuel is cheap, “fuel up the jet and get out of the Prius”. Genius quote, love it!

  64. Alex Murphy

    Capital is jetfuel if you are essentially break even, trying to focus in on customer development, trying to get out the marketing funnel works, and an investor comes in and dumps capital on your company saying its time to “shock and awe” spend like there’s no tomorrow because all you have is the next 6 months, then go raise another round.In this scenario, you run out of money, and if the market isn’t right in 6 months, your burn rate is such that you are out of business. Sounds like blowing up with a smart cart to me.

  65. William Mougayar

    OK as long as that Prius driver can drive a jet…otherwise, back to disastrous outcomes 🙂

  66. William Mougayar

    Chuckling…thanks for sharing. Seems like there’s a market opening for a Prius-Jet.

  67. ShanaC

    You’re a Good Man Charlie Crystle.

  68. George A.

    A prius in the valley is all about access to HOV. Incentives determine behavior.

  69. fredwilson

    not really

  70. fredwilson

    you lie down with dogs, you come up with fleastaking money from inexperienced investors is most likely lying down with dogs

  71. Donna Brewington White

    “TheFunders, where VCs rate each other”Love it.

  72. Dave W Baldwin

    That is the point of working with the right investors if possible. If $2mm will get you to realistic milestones, the better investor knows what you will be talking about at that time.For the investor who thinks, throw $5mm and it will make that much more, do not be fooled…that investor will not accept anything lower.