One of the central dilemmas for venture capital managers is whether it is possible to earn money from venture capital with a certain level of guarantee. In banking, there is a win-win model: you take deposits at one percent, issue loans at another, and have a guaranteed income on the difference. In venture capital, where 70% of startups die within the first five years, 65% of venture deals return less than the capital invested, and the top-10% of funds take more than 60% of the total profits of the venture market, there seems to be no such guaranteed model (or only these top-10% understand it).

In this article, I aim to explore what such a model might look like.

Private markets are both close to and very distant from public markets. The main difference lies in how the “fair” price of an asset is formed and how investors earn money. In the public market, it is always “the market that decides,” and insider trading is prohibited—regulators ensure that information is delivered symmetrically to all interested parties. Most people are accustomed to operating within this paradigm, even when they enter the VC world.

And when they are venture capital, it takes them several years to realize that in the private market, everything is precisely the opposite - there is complete asymmetry of information, insider trading is not only legal, but it is only thanks to your information advantage that you can gain access to a deal and make an investment decision; There are no fair valuations or multipliers—only those that you yourself managed to negotiate.

For scouting deals, analyzing them, and helping a portfolio startup grow, what matters is the strength of your network effect — how much information you have access to that others don't. If the public market is a fair fight between two armies with swords, then the private market is a spy game between special services. But it is precisely the understanding of how to “play” and do business on the network effect that increases the likelihood that you will make money on venture capital.

What do I mean? If we schematically depict private markets, we identify four types of “players”: us, the founders, other investors, and customers. Each type can interact with any other. And your ability to influence each of the other three directly affects the likelihood of your investment's success.

The size of your exit earnings is made up of several components: startup capital * multiplier. And the multiplier includes traction * hype. So the formula looks like this:

Exit/round valuation = capital * traction * hype.

When I talk about hype, I mean two irrational things:

1. For investors, it means a willingness to go in at unreasonably high multiples “just to be part of the deal.” In other words, hype affects risk perception. If you look at the multipliers of unicorns, they are way out in space relative to the market average, and it seems that none of the investors care. The decision is made not by logic, but by “social confirmation.” And this can be controlled.
2. For customers, the desire to pay money for this particular product, and not for a competitor's. The reasons can range from “an opinion leader recommended them” to “I heard about them first, I don't want to look at anything else.”

When an investor interacts with other investors (funds, syndicates, or limited partners), they do several things at once:- accumulates more capital that can flow into the startup,- influences the interest of this capital in the deal by correctly directing the attention of decision-makers,- creates hype around the deal, increasing FOMO and, thanks to this, possible multipliers in the deal.By interacting with other investors, you influence capital flows and hype, helping new rounds proceed, and at the same time creating space for yourself a the future exit.

When an investor interacts with clients, they can contribute to:- the influx of new clients and the size of contracts concluded with startups — this has a direct impact on the traction of the portfolio project;- the influx of new partners who can provide unfair competitive advantages in the form of exclusive access to audiences, resources, or technologies;- this, in turn, raises the expectations of other investors, accelerating the valuation and multipliers for the startup's valuation.By making money for the portfolio project, you make money and create the opportunity for a bigger exit for yourself by influencing traction and hype.

When interacting with a founder, an investor cannot directly influence capital, traction, and hype. However, they can contribute to the professional development of founders and teams, helping them make informed decisions that do not undermine efforts to attract other investors and customers. It's like building a tower on three pillars — it can only stand steadily when there is support from all three sides.

When an investor begins the path in venture capital, they typically have weak connections with other investors and clients. Many first-time GPs try to be a kind of “accelerator” for startups, helping with whatever they can—hiring, financial modeling, fundraising. These are important things, but they do not directly lead to earnings, growth, or exit, as they have no impact on capital, traction, or hype. These are referred to as “smart investors.” They make a lot of gestures to compensate for their lack of real influence on the company's success, but continue to hope for a miracle that a tier-1 fund will take an interest in the startup. They don't create that miracle.

The key magic of an investor is the ability to proactively “inflate” the valuation of a private company, “bringing” it to the right doors, helping with accessible capital, traction, and hype. One of the central cognitive biases in venture capital is the belief that funds such as Sequoia, Target Global, and Accel possess secret knowledge about startups or founders that is unavailable to others, which enables them to regularly “find” future unicorns. So, the whole secret is that they don't find anyone. They make them. These funds take a proactive stance and have such a network effect that they determine which of the many competing startups will grow into a unicorn through their financial and social resources.

A separate question is whether hype directly affects valuation growth and whether it can be managed. And the big guys, like a16z, say it can. To do this, you have to become opinion leaders yourself. Create an information bubble around the startup. Create an image of yourself as the “leading expert” in technology. Have a large team of PR and marketing specialists, use many PR technologies, and create hype on social media. Just as the media is the fourth branch of government, PR in venture capital is the fourth force shaping a startup's success, alongside the team's capabilities, capital, and traction.

A16z allocates tens of millions of dollars annually a content, its own media, community, recruiting, and GR. These investments yield substantially more revenue than spreading this money across 20 companies.

To understand venture capital, you have to recognize that for every unicorn, there are a dozen similar companies that have been invested in by simpler funds, which may have had the best product at the time, better technology, a more experienced team, the same amount of money in their accounts, and the same growth metrics, but which failed to conquer the market simply because they were not backed by Tier -1 investors, Google and Nvidia was not brought them as clients from the right person, opinion leaders on Twitter did not write about them, no social proof effect was created around them, they were not spread across a network of podcasters, and no hype or multiplier was pumped up for them.

It is important to recognize that information is constantly traded in private markets. It circulates among all of the above-mentioned players. This information includes criteria for trustworthiness, available volume, acquisition speed, and processing quality. Investors are determined by the level of each criterion's development. The ability to use this information to one's advantage is practically the only thing that makes a portfolio startup big and prevents it from getting stuck at the Series A stage, when there seems to be development, but it is not possible to attract subsequent rounds and larger clients because there is no hype bubble around the project. 

A top investor is an information broker with substantial social capital, which they monetize through venture capital, creating unicorns rather than finding them. Venture capital is a market with highly uneven outcomes, and it is naive to believe that the top 10% of investors do not control the market for their own benefit.

Among founders, the most ambitious understand that they want more than just “smart” investments; they seek investors who will serve as partners who act as a social elevator for the startup into the world of big players and valuation. And since the concept of a smart-investor is about something else, as was previously mentioned, I suggest calling such funds, aka social elevators, wise-investors.