Believe it or not: 90% of the VC job is sell-side, not buy-side

A common misunderstanding about our job is that people assume that all we need to do is to decide which startups to invest in. In other words, people assume that we are mostly doing the buy-side job.

But if you ask most genuine venture capitalists, I'm pretty sure you'll get the opposite answers: 90% of our job is actually sell-side, not buy side.

 

What is sell-side/buy-side?

For those of you unfamiliar with the finance jargons, sell-side means the side of selling financial assets and buy-side means the other end of the transaction, simple as that.

However, depends on which part of the financial industry one's in, the two could have significantly different levels of difficulty and complexity.

For most people, financial industry is all about stocks and bonds. Since anyone can buy and sell bonds, the buy-side/sell-side dynamic seems to be symmetric.

However, if we move the discussion forward to the IPO stage, not all people get access to the IPO shares and not all shares have potential buyers. The question starts to become very different.

For the most part, IPO is a sell-side job undertaken by the investment banks underwriting it. The investment banks have to map out the industry landscape, project the company's performance well into the future, build out the valuation models and most importantly, persuade brokerage clients to subscribe for the IPO shares. In this scenario, sell-side is undoubtedly much more difficult than buy-side, which is why most tier-1 investment banks charge a whopping 7% of the cash successfully raised in IPO.

In the height of the dot-com bubble in the late 90's, the IPO market looked a bit like a buy-side market as investors fought to get into the hottest IPO deals, thereby enriching certain investment bankers who controlled the IPO pipeline such as Frank Quattrone. But for the most part IPO is a sell-side job — the financiers have to persuade the buy-side people why they should subscribe to these shares at such share prices.

Hedge funds, on the other hand, are buy-side jobs. Being able to identify public financial assets that are wrongly priced and create a mechanism to maximize the potential returns, usually through leverages. This takes a lot of effort and talent (and obviously luck).

On the other hand, modern activist hedge funds behave both like buy-side and sell-side. First they identify stocks that are wrongly priced. They build a substantial position through complex derivatives or simply buying stocks on the market. So far the job is buy-side. Once they have an influential position, they switch to sell-side and go on the media to criticize the company's strategy hoping to coerce the board into making some decisions that would trigger a sudden stock price change, such as divesting a department or buying back stocks. All those trumpeting is practically "selling the idea" that should eventually make them profit from the change.

As readers might detect, here I introduce the key element that addresses my argument about "VC is a sell-side job" — it really didn't matter who's ultimately paying cash for the assets, whoever is working very hard to convince the other side is the real sell-side.

Now let's see how VC work hard to convince everybody, while most people believe the other way around.

 

Deal flows

Deal flows basically mean the proprietary startup pipelines that allow the VCs to identify the right startups to bet on.

While the numbers vary a lot, a tier-1 VC in Silicon Valley could have up to 6,000 startups that come their way, whether in the form of inbound pitches, referrals or active sourcing.

Without these 6,000 startups, a tier-1 VC won't be able to do its supposedly buy-side job, which is to select on the 10 startups that it wishes to invest in.

To build up a 6,000/year deal flow, on the other hand, is 100% a sell-side job.

Who are the buyers in this case? The startups.

What do VCs sell to startups? That they are the smartest and most value-adding investors that the startups should come to them, and choose them as investors eventually when the VCs do (occasionally) choose to invest in the said startups.

If you're already a tier-1 firm, such as Sequoia Capital or KPCB, this is probably an easier job. However, you still see the best General Partners in the best firms fighting to get into a potentially great deal, as exemplified by the now legendary act of Sequoia's Jim Goetz persuading Whatsapp to take the cash that the latter did not need.

And if you're a new VC firm, by all means you have to work very hard to sell to the startups about yourselves! Andreessen Horowitz (a16z) would be the role model of this sell-side job and part of the story could be found in the must-read The Hard Thing About Hard Things by Ben Horowitz.

 

Exits

This is simple. Exits are fundamentally a sell-side job for the VCs as they'll be selling the shares they have whether it's an IPO or an M&A exit.

However, that doesn't mean that VCs just sell startup shares as if a random individual sells his Facebook stocks on e*Trade. Most M&A exits don't happen by themselves. Potential buyers have to be identified and strategies have to be defined to get them on-board. Sometimes assisted by M&A investment banks, this tasking job usually falls on the VCs that have the most stake in a particular startups. As a result you sometimes even see partners in late-stage VC firms that actually came from M&A backgrounds instead of entrepreneurs, exactly for this reason.

That said, the best VC strategy is still to invest in great entrepreneurs. Trying to sell a lousy startup is usually not worth the partners' time. It's better just to let it die.

 

VCs have to fundraise themselves!

Most of the time entrepreneurs forgot about this fact: VCs have to raise money themselves as well!

Professional VC firms manage VC funds, the capital of which comes from investors that are called LPs (Limited Partners). To get the LPs to commit investments into the funds, the VC firms, hereby acting as GPs (General Partners), have to work very hard to persuade them.

Typical LPs in VC funds include asset management firms, endowment funds, pension funds, family offices, HNW (high-net-worth) people, successful entrepreneurs, etc.

Most of these LPs are financial managers themselves, who have a fiduciary duty to their own investors to generate the designated risk-adjusted returns and to meet many other secondary requirements. For them to take a VC fund as part of their portfolios that is high risk and illiquid, it takes a substantial amount of sell-side effort to achieve it.

If you don't believe me, just ask any VCs what they hate most in their jobs, 9 out of 10 times it's gonna be fund-raising. Most of them are very smart people who just want to get the funds ready and be able to invest in the exciting entrepreneurs that they have found.

When the LPs are successful entrepreneurs things are usually easier since they already went through the risky entrepreneurial path themselves. They also aren't necessarily fixated on risk-return profiles — which are very difficult to model in the VC industry where returns are highly skewed and often repeatable — and would be able to invest in a fund whose vision resonates with their own.

However, successful entrepreneurs also tend to feel that they could make better decisions than fund managers since they have been successful. To persuade them to become your LPs usually isn't a job that could be done with rationales or market numbers. An 18-hole golf course on Saturday morning might be more effective than slides. Or even better: be an even more famous and more successful entrepreneur yourself, such as the case in Peter Thiel's Founders Fund and again, Andreessen Horowitz.

 

Eco-system partners

This is particular to us hardware investors. Our startups need a lot of business partners to be successful, among all manufacturing partners and distribution partners. 

At the Hardware Club we have built more than 50 manufacturing partnerships, including the top 9 EMS companies in the world: Foxconn, Pegatron, Quanta, Flextronics, Compal, Wistron, Jabil, New Kinpo and Inventec. Together they account for more than $280B of revenues every year. To persuade them to partner with us and to work with early-stage hardware startups, it takes lots of sell-side effort from our side in aligning long-term interests of everyone in this startup-VC-EMS triangle.

The same for the 40+ retail and distribution partnerships we've built, including Amazon, Brookstone, Bestbuy, Target, Toys R' Us, JD.com, Fnac, Media Saturn, etc. For them to deal with random startups with unstable invoicing/shipping behaviors, it's a nightmare. It has taken substantial sell-side effort from our side to convince them about the values created in working with the best of the best hardware startups.

In short, by no means we're just sitting there and these great partners are knocking tenaciously on our doors just because we have the best hardware startups in the world. It takes the same salesmanship to convince these big corporates the merits that lie in it.

 

Conclusion

While most outsiders think a VC's job is the same as a stock picker, which is to make better decision in buying stocks than others. It could not be further away from the truth.

90% of our job is sell-side, if not more. Making the buy-side investment decisions is key to our eventual financial performances. However, without the 90% of sell-side effort, we may never get to choose, to exit and even to have the money to invest!

 

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