Is much of venture capital just hype/a self-fulfilling prophecy?

I am 23 and new to the venture capital world, working at one of the midsize VC firms.

I'm somewhat astonished at how many startups with a mediocre product, barely any revenue, and/or questionable business plans I have seen blow up in terms of valuation.

It seems to me that funding and valuation out here is almost a game. You hype up your product as groundbreaking, get series A funding from one of the big names (Andreessen Horowitz, Sequoia, etc) and a headline comes out that _____ firm invested millions in your Series A. Then, simply because the big names gave you money, in the next round other firms and institutions give you even more money because they don't want to miss out on the next big thing. Valuation continues to skyrocket even though revenue and customer base size has remained the same.

In the media, you have seen some of these CEO's be exposed as frauds and a few indicted. Theranos, Nikola Motors, WeWork etc. 

Those CEO's were fired and/or indicted because they kept the train rolling until they were billionaires. But I know several dozen founders who have done the same thing at a smaller scale, were acquired, and cashed out at $10-50m knowing damn well that they made out like a bandit. 

I'm not saying all startups operate this way, there are many that have a great product or idea. But you'd be surprised at how many do. And I can't say I blame them; think about it-Nikola and Theranos raised BILLIONS with no one taking the time to verify that they had a working product. Adam Neumann and WeWork used "community adjusted EBITDA" in their financial statements. Part of Elizabeth Holmes's defense at trial is literally going to be that everyone in Silicon Valley exaggerates and/or makes misleading statements to investors.  It's crazy to me.

Comments (28)

Sep 5, 2021 - 5:13pm
2rigged2fail, what's your opinion? Comment below:

the sooner you learned everything is a rigged game, the better.

  • 1
  • Prospect in IB-M&A
Sep 5, 2021 - 7:29pm

Username checks out

Sep 6, 2021 - 4:55pm
maestro_, what's your opinion? Comment below:

The cycle you describe is dependent on new money investment into venture. Eventually, the money spigot is going to turn to a trickle and things will be bad (I'm not really talking about interest rates, but that is related). 

Sep 7, 2021 - 10:27am
acardboardmonkey, what's your opinion? Comment below:

There is a difference between an increased valuation from a new round and an exit. It's great when your $10M post-money Series A Investment quintuples in the Series B, but it's just paper gains until you have your liquidity event. I think more of the market is realizing this, which is why the secondaries space is growing so much imo

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Sep 7, 2021 - 12:50pm
Keyser Söze 123, what's your opinion? Comment below:

I've been in the industry for about 6 years.  It's an ugly truth to the business, I notice it, and agree with everything you've said, but the game has been played this way since the beginning of the capital markets and it will never change.  Investors are people and the fastest way to separate them from their cash is to get them excited about what a company does.  Business Owners/Financial Professionals stay up at night thinking about how to get investors excited about a business (sometimes stretching the truth intentionally or unintentionally about its capabilities), which is why a good investor needs to keep their own objective opinions of the business outside of what the industry and marketing excitement says.  Watch any talk from Warren Buffet and Charlie Munger and they will almost always stress "objectivity" and not getting caught up in the excitement of an industry.  That is because high valuations are only real if investors make them real, and just because they are real does not make them correct.  

It's a tricky game, but it is also what makes the deal industry so fun in my view.  Is it the obligation of the business owner to be forthright, or is it the obligation of the investor to be intelligent?  In an ideal world, it would be a little of both, however, in reality, only the latter will protect you.

Fortunately, we all have the benefit of hindsight in the many historical cases of overvaluation, fraudulence, or bad business planning that you brought up.  However, for the person in the seat making the investment decision, there were so many more unknowns that factored into their decision.

"A man can convince anyone he's somebody else, but never himself."
  • 9
Sep 7, 2021 - 2:07pm
HowlerMonkey, what's your opinion? Comment below:

Only thing I'd take issue with is founders cashing out for $10-$50 million and making out like a bandit. Funding round valuations - of common stock at least - are often ridiculous, but as others have pointed out they're paper / largely meaningless. An acquisition, on the other hand, is an actual liquidity event and is paid for with real money (cash or the highly liquid stock of a huge acquiror). If you're a founder and making that kind of $ on an exit, you are doing a deal that your VCs want to do (you usually can't sell without their support), the deal value meaningfully exceeds the VCs' liquidation preferences, and your company is generating real revenue. Plenty of exceptions to the last one, but far fewer to the first two.

Sep 7, 2021 - 2:14pm
thebrofessor, what's your opinion? Comment below:

a lot of it. although many smart VCs are aware of this and so throw a bunch of stuff in the portfolio with the hope that one of them becomes the next FB and gives them a good enough CAGR to justify a 2% fee plus carry to their investors. so yes it's overhyping, but it's also risk management, today's zero profit dog may become a S&P component in a decade or less.

  • Prospect in IB-M&A
Sep 8, 2021 - 12:43pm

This is largely caused by just how much capital is out there. It was like this in the leadup to the dotcom bubble bursting except back then there was even more fraudulent startups from what I've heard. I do think that getting a top-tier VC investor on board can kind of lead to a "self-fulfilling prophecy" in some cases where a startup gets access to customers and people they would've never been able to. 

Sep 8, 2021 - 4:05pm
PEarbitrage, what's your opinion? Comment below:

For those of you interested in how the fundamentals for value capture have changed in the industry over the past 40 to 50 years this is a really good talk given by  Chamath Palihapitiya on how the incentivies have changed for fund managers. 

Sep 16, 2021 - 11:29pm
nanometers, what's your opinion? Comment below:

I did valuations for pre-seed and seed companies as a contractor for 5 different int'l based firms (with small offices in the bay area ~2-3 partners). It's certainly not uncommon to see minimal effort toward PMF or customer gathering as long as there's some form of traction that justifies (re: loose term) a next step. The deluge of capital since 2018 has been impressive, especially as FOs or big institutions leave hedge funds for P/E and venture $, as well. It's remarkable how many companies are formed, though, that the reverse can be true if you niche down - companies that drive A LOT of value that don't get the media attention because they were invested in a mid-to-small tier VC and actually executed, got revenue/customers/PMF and then are sold quietly. More visibility but certainly a wider market now. 

Sep 17, 2021 - 12:59am
scrubmonkey, what's your opinion? Comment below:

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Sep 17, 2021 - 3:35am
TheBuellerBanker, what's your opinion? Comment below:

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