Musings on Entrepreneurship and Innovation
Wednesday, August 18, 2004
The Myth of VC as Operator Hero
In a thoughtful piece titled The Perfect VC: Operator or Investor?, Bill Burnham at Softbank Capital Partners decries the image of venture capitalist as "operator hero":
...when you catch most VCs in a moment of honest reflection they will tell you that while they enjoy working with their investments and trying to “add value” by using their operating experience, the single most important action that they take is deciding whether or not to invest. This is because a start-up’s initial “genetics” in terms of market opportunity, technology and founding team are typically the biggest determinants of investment’s success. Put another way, it’s almost impossible to turn a start-up with bad genetics into a good investment, no matter how good an operator you are. Thus, if the initial investment decision is so critical, than it stands to reason that investment skills are potentially more important to VC success than operating skills.
...this is not meant to say that operating experience is of no value to becoming a successful VC, indeed many of the world’s most successful VCs have highly distinguished operating backgrounds. However it is meant to suggest that the recipe for VC investment success may be a bit more complicated than conventional wisdom might suggest.
My Venture Dynamics Group colleagues and I share Burnham's perspective that a system's structure drives its performance. A poorly designed organization in an adverse market environment is not likely to succeed, no matter how efficiently it is operated. Consequently, the most most important decisions that VCs make are, indeed, investment decisions. In fact, it's possible that an over-confident operator-VC might be more prone, on occasion, to make the crucial error of putting good money after bad.
Earlier this year, I spoke with my former private equity colleagues who are now at Hunt Private Equity Group in Dallas. They had just completed an exhaustive analysis of their historical investments in order to identify patterns of performance. They found that they only consistent trait among their most successful investments was "momentum," which I take as the equivalent of Burnham's genetics metaphor or what we at VDG would call business physics.
Nevertheless, I strongly suspect that the "optimal" mix of relative experience for a VC changes over time, because the mental models that we all have are shaped by our experiences, and those mental models determine what we see and, consequently, how we perceive the structure and physics of a business. During the late 1990s, which were marked by a hot IPO market, speed-to-IPO was the mantra, so sales, marketing, finance, and transactional skills were relatively important in assessing an investment's genetics or physics. In the current environment, the relative importance of operating execution has increased. A VC who can perceive the world with both sides of the business brain has an advantage.
Even so, Burnham's main points are spot on. In an uncertain world, a well coordinated team will outperform the lone genius. VCs can play a critical role in the development of a company, but their comparative advantage must be in the assessment of business dynamics and making capital allocation decisions. A competent VC (regardless of his or her personal background) teamed with a competent management team operating in a sufficiently favorable environment will likely outperform the singular "operator hero" VC.