Eric Falkenstein presents some strong evidence against this in his book Finding Alpha. Low risk equities outperform high risk equities. The difference between equity and bond returns probably reflects something other than risk.
He also claims that private equity doesn’t outperform publicly traded equity (suggesting that startups aren’t a good investment, although “startup” doesn’t seem to be a well defined category).
That still leaves an interesting question about whether it’s wise to increase risk via leverage.
“startup” doesn’t seem to be a well defined category.
Here is Paul Graham’s definition:
A startup is a company designed to grow fast. Being newly founded does not in itself make a company a startup. Nor is it necessary for a startup to work on technology, or take venture funding, or have some sort of “exit.” The only essential thing is growth. Everything else we associate with startups follows from growth.
That is from http://paulgraham.com/growth.html where we also find an explanation for why startups might outperform other classes of non-publicly-traded investments. Specifically, the explanation is that startups have less need for costly financial controls to protect the interests of the investors:
The other way to get returns from an investment is in the form of dividends. Why isn’t there a parallel VC industry that invests in ordinary companies in return for a percentage of their profits? Because it’s too easy for people who control a private company to funnel its revenues to themselves (e.g. by buying overpriced components from a supplier they control) while making it look like the company is making little profit. Anyone who invested in private companies in return for dividends would have to pay close attention to their books. The reason VCs like to invest in startups is not simply the returns, but also because such investments are so easy to oversee. The founders can’t enrich themselves without also enriching the investors.
Designed to grow fast is hard to observe. The supply of companies appearing to fit that description increases to satisfy VC demand. The money in VC funds exceeds what the few VCs who are able to recognize good startups are able to usefully invest.
Did you read the part where Paul Graham implies that a significant fraction of the startups in his program (YC) grow at a rate of 5-7% a week? I.e., every week they get 5-7% more users than they did the week before.
Yes, most of these users are non-paying users, but the experience of VCs and angel investors has been that if even one startup in an investor’s portofolio manages to acquire multiple 100s of millions of non-paying users, that startup will usually eventually figure out how to make enough money to make up for all the failed startups in the portfolio.
The money in VC funds exceeds what the few VCs who are able to recognize good startups are able to usefully invest.
This reminds me of a piece of advice I’ve read—before making an investment, ask yourself whether you’d make the investment if the only person you could tell about it is your accountant. In other words, suppress the desire for bragging rights.
If the desire to make an unlikely win is common among investors, then too much money will be put into risky investments.
Eric Falkenstein presents some strong evidence against this in his book Finding Alpha. Low risk equities outperform high risk equities. The difference between equity and bond returns probably reflects something other than risk.
He also claims that private equity doesn’t outperform publicly traded equity (suggesting that startups aren’t a good investment, although “startup” doesn’t seem to be a well defined category).
That still leaves an interesting question about whether it’s wise to increase risk via leverage.
Here is Paul Graham’s definition:
That is from http://paulgraham.com/growth.html where we also find an explanation for why startups might outperform other classes of non-publicly-traded investments. Specifically, the explanation is that startups have less need for costly financial controls to protect the interests of the investors:
EDIT. Fixed the URL.
Designed to grow fast is hard to observe. The supply of companies appearing to fit that description increases to satisfy VC demand. The money in VC funds exceeds what the few VCs who are able to recognize good startups are able to usefully invest.
Did you read the part where Paul Graham implies that a significant fraction of the startups in his program (YC) grow at a rate of 5-7% a week? I.e., every week they get 5-7% more users than they did the week before.
Yes, most of these users are non-paying users, but the experience of VCs and angel investors has been that if even one startup in an investor’s portofolio manages to acquire multiple 100s of millions of non-paying users, that startup will usually eventually figure out how to make enough money to make up for all the failed startups in the portfolio.
Agree.
This reminds me of a piece of advice I’ve read—before making an investment, ask yourself whether you’d make the investment if the only person you could tell about it is your accountant. In other words, suppress the desire for bragging rights.
If the desire to make an unlikely win is common among investors, then too much money will be put into risky investments.
http://www.economist.com/news/finance-and-economics/21571443-investors-may-have-developed-too-rosy-view-equity-returns-beware-bias is relevant and recent.