I think one of the most interesting paragraphs in this essay is the one discussing where VC money comes from. This seems to be something that is not very clear on HN, and without understanding who's money it is and who is spending it, it is hard to understand the incentives behind VCs, which seems like an important thing to understand for anyone contemplating a startup.
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It's interesting but not an entirely accurate picture. It may be accurate for some VCs but definitely not for all of them or even enough of them to state this with such confidence and as though it is the rule rather than the exception.
Depending on the VC you could be looking at former technology entrepreneurs that have sold their business(es) and are re-investing the proceeds, collectives of those, VCs run by financially savvy accountants or similar that work on behalf of a usually much larger number of LPs and so on. In fact the number of VCs that have institutional partners such as teachers unions is probably relatively low because of the fact that the 'risk profile' of VC is higher than what those institutional investors can stomach, though if a VC were able to raise capital from such a source they'd definitely go for it.
So that doesn't mean it doesn't happen but it's not the structural motor behind the SV capital engine, just like your average pension fund isn't going to go to the casino with their holdings, it would be against their fiduciary duty to do so, and quite a few pension funds are already in trouble with their more risk averse investments done in the past. The last thing they need is to go for an even riskier bracket of investment.
I think it would need a bit more evidence before I'd be convinced that this is the case, it runs directly against what I know of those venture capital companies that I've looked at in the past.
What I meant, and what I think Michael O. Church meant, was more that VC money doesn't come strictly from the VCs themselves. In most (nearly all?) cases, there are a number of LPs whose money the VCs are investing, and the VCs invest relatively little of their own money in each investment.
It's also worth noting that the vast majority of VC firms are not KPCB or Sequoia or one of the other "name-brand" VC firms, and that most entrepreneurs who receive funding will not do so through one of these firms either.
And while it's probably true that most VC money is not from pension funds, much of it is institutional in origin (incl. state pension funds), just as much of hedge fund money is institutional, and the VCs themselves take on limited risk, since they typically get a management fee, and then some sort of performance fee as well, while risking relatively little of their own capital (2 and 20 is common among VCs as well as among hedge funds). The underperformance of VC as an asset class is well documented as well.
This paper [1], which is the Kauffman foundation's assessment of the performance of its VC related investments, describes in detail the VC industry as it currently functions. I think you'll find that it is closer to the way Michael O. Church describes it, than to your conception of it. Everyone considering a startup should at least read the executive summary.
[1]: http://www.kauffman.org/~/media/kauffman_org/research%20repo...
There's a reason the term 'dumb money' exists. For the Kauffman foundation 14% or so of their capital goes to a very large number of oversubscribed VCs without much oversight and they're (typical) bitching about their returns.
Think of it as a very wealthy man that goes to the casino and that decides to play on all tables at once and is surprised that he's not structurally winning, whereas that's exactly what you should expect. The house always wins and if you play more you should expect on the whole to lose more. It's the outliers that power the VC industry, not the averages.
VCs will (as I wrote in the previous comment) happily take that money but institutions such as these should be very careful where they invest their money, the risk bracket that VC is traditionally bucketed into is not compatible with the security and level of returns that they are seeking. It's funny how they want higher returns than the stockmarket but are surprised that the higher risk associated with those returns has a habit of materializing in the form of lackluster average performance.
When VC pays off it pays of handsomely, but the fact is that plenty of times after all the numbers have been computed and the fees have been subtracted that there is little left over for the original investors (and quite a few funds will be left with a loss). That's the nature of the game, hence the 'venture' part of the word.
Pension funds and other institutions normally place the bulk of their investments in more secure places (as they should).
The root of the problem described here is this: there is simply too much capital and there are (by definition!) too few outliers to generate a good return on all that capital.
So if you play all the tables you can only lose to the house. On the other hand, if you play very selectively (the way you should), do proper DD on the VC firms that you deal with and negotiate good terms there is money to be had, but not at the scale that these funds tend to require.
If you invest 280 million and expect a 2:1 return on investment in 3 years then you're going to be disappointed. That 280 million is a very small fraction of the total VC available and the number of successes is small enough that a low return on investment is pretty much a guarantee. But 40 or 50 million in the right spot might generate a huge return.
In Europe - where the number of outliers since 1980 can be counted on one hand - the situation is much, much worse.
VCs will always chase the outliers, and will leverage as much as they can to reduce their own risk exposure. It takes two to tango and if institutional investors want to play the lottery I say more power to them but they should realize exactly what they are doing (and I think most of them do, which is why on a percentage basis only a small part of those funds will make it to the VC war chests).
On the whole, I'm somewhat surprised by the amount of naivety on display in that document, as well as a strange undercurrent of 'this worked in the past, why doesn't it work today', which is a tell-tale of a broken investment strategy. The years around 1995 are in no way to be compared with 2009 onwards.