AGILEVC My idle thoughts on tech startups

August 17, 2009

As a VC, it’s not always easy explaining what you do for a living to people who may not be intimately familiar with the startup ecosystem.

Most folks might understand that VCs invest in innovative companies. But there’s also plenty of misconceptions that we’re involved with small business finance (we’re not… we’re in the business of financing big companies, but just try to do so when they’re still small). We’re not public market technology investors, though a small number of VCs will do the occaisonal PIPE. We don’t back not-for-profit organizations, despite the fact that we all make our fair share of non-profit investments. My favorite was trying to explain my job to my wife’s late grandfather some years back, a wonderful gentleman at an advanced age. My wife’s sage advice was just to say that I was a stockbroker and leave it at that…
But the question of what we actually do, as an analogy to other professional roles, has always been a bit elusive for me. There’s unfortunately no single analogy, but there are some rough ones which can apply and these get at the heart of the question of what makes a successful VC.
1) VCs as Headhunters / Recruiters – You could say that what we fundamentally to is scout entrepreneurial talent. Basically every VC will say that management teams are the most critical factor in the success or failure of a startup. So arguably our job is primarily about getting exposed to as many exceptional founders and startup managers as possible, and then “recruiting” the best of these folks into investment portfolios. This analogy perhaps holds best for the earliest stages of VC investing, when a startup has little to no historical performance in terms of products, financials, or other business metrics to evaluate. That said few VC professionals come from the recruiting & staffing industry, though there are a small number of exceptions like David Beirne of Benchmark.
2) VCs as Stockpickers – Another approach would be to view VCs as investment mangers in the most traditional of senses. The average VC sees hundreds of business plans each year, meets with dozens of companies, but ultimately only selects a couple companies to invest in (or at least try to invest in). At the earliest of stages though, there’s astonishingly little “hard” data to analyze for the purpose of making a VC investment decision. Later stage VC investing perhaps might be more akin to stockpicking, but even still the total mass of historical facts about a startup only a few yrs old is quite modest. While a good many of VCs began their careers in investmtent banking, relatively few actually come from true investment selection or portfolio management whether it be in hedge funds or mutual funds or other vehicles.
3) VCs as R&D Directors - Some would argue that VCs fundamentally serve the macroeconomic function of allocating research & development dollars to the most promising technological innovations (well at least development, but not really basic research). To me though, this analogy is one of the weaker ones. Even VCs who come from technical backgrounds, perhaps as CTOs or VPs of Engineering, don’t really set about trying to efficiently allocate dollars towards research as an end to itself. We certainly fund innovation, but that’s neither our raison d’etre nor our modus operandi. That being said, for certain sectors of startup innovation having a solid grasp of why a core technology is groundbreaking is truly invaluable as an investor. There’s a reason why a non-trivial percentage of successful biotech VCs have advanced degrees (MDs, PhDs) in life sciences.
4) VC’s as Corporate Managers – These folks suggest that VCs in essence add/create lots of value by serving on the board of directors of our portfolio companies and providing them with lots of strategic advice, introductions, strategy, etc. There are even occasions when VC investors step in and take control of companies for a period of time as interim CEO or Exec Chairman, though these are typically dire situations where a “turn around” is being attempted. With this labor analogy being an active, hands-on, value-added investor is what really counts.
The question of how much value VC investors add or create for startups in legitimately debatable. Most big decisions in a company’s life cycle do involve VC investor / BOD members, and occasionally VCs certainly deserve much of the credit for pivotal events like recruiting new leaders or driving a strategic acquisition process. But on the flipside virtually all of the day-to-day hard work of building a big company from scratch is done by the founders and team. It’s a bit like the coach of a sports team… were the Chicago Bulls wildly successful because of Phil Jackson or Michael Jordan? There’s no way to definitively settle this question of course, and undoubtedly both of them were factors to some extent. But having sat in both the player and the coach’s seat now, I know I personally am going to bet on Michael over Phil pretty much every time.
I think the best VCs are good, at least to some extent, at playing all the roles above. There are a handful of truly exceptional VCs I respect who really excel at #4, though I’d have to say most of the best are truly great at talent scounting in their own way. What do you think? Are there other analogies more apt?