What do you mean they don't make money that way? Do you just mean that $100m isn't a hit? If that's all you mean, change that number to $1b or $10b or one hundred... billion dollars (pinky to lip). But I think what you mean is that investors make money by finding companies that are grossly undervalued, to the point that an order of magnitude change in valuation shouldn't affect the decision. I'm still skeptical of this claim. How many companies valued at $10m do you think have a 10% chance of ending up at $1b+?
Almost all phase 2 startups will be worth zero, or nearly zero. Some will be worth $BIGNUM. If you invest in the latter, you will be rich irrespective of whether you invested at a valuation of $BIGNUM/100 or $BIGNUM/200. If you invest in the former, you will not be rich.
Moreover, whatever money you make on any startups that do not make $BIGNUM is rounding error by comparison.
Your questions are interesting, because (outside of the startup world) they are based on sound logic. The basic rules of expected value don't apply to startups, because the present value is not a good predictor of future value. Some people are good at predicting the outcome (success vs failure), but nobody can get the number right ($10m vs $1b). Any investor who lets marginal changes in valuation influence his decision is essentially calculating a probability using a random number.
> The basic rules of expected value don't apply to startups
If you'd reword that as "the basic rules of expected value are difficult to apply to startups", there'd be some chance it was true :).
And yet, difficult as it may be to apply, expected value is the framework to rationally make a decision about low probability / high payoff investments. Of course, if YCombinator is already invested at an early stage (note: when the valuation is quite low), I can understand why pg wouldn't care too much about the later stage valuations. If you look at what's best for YC, it's first and foremost that companies get the money they need to succeed (an incentive aligned with the founders and any investors) but probably also that the valuations (after their own investment) be as high as possible so that more of the pie remains for later investments. This latter incentive is clearly not aligned with investors and as an investor I'd take the advice to disregard valuation with a big grain of salt.
Excerpt: "To a first approximation, a VC portfolio will only make money if your best company investment ends up being worth more than your whole fund." This is the big hit, and VC's are trying to optimize their chances of getting one of these. That's different from trying to precisely calculate expected return. As long as you've found it, it won't matter if you paid a bit too much.
