[The article has been supplemented by a more recent “Why VCs really need relevant operational experience, now“]
I frequently get asked by individual Venture Capitalists (VCs) whether I think General Partners (GPs) need operating experience to be more effective (as if my blog is not clear about that). And just recently HP’s Venture Group seems to agree with me.
That topic was also recently challenged by Daniel Primack from Reuters’ PEHub (I know he likes a good debate) who decided to make a statistical point that there is no correlation between fund success and GP operating experience.
My short answer is: “Yes, but it depends.”
What my answer does not depend on is Daniel’s statistical analysis of the Forbes Midas List and loosely matching credentials to his sample. With more than 90% of VC not making a real profit (above the asset class expectation of it), the 10% Midas sample can hardly be called statistically representative. And even if it would, a highly inefficient market (created by the ineffective “dating service” VCs currently provide) does not statistically represent the workings of the efficient market we wish for. And the majority of the Midas List GPs have their “success” firmly rooted in a timeframe when “turkeys could fly.” Should I go on?
But most importantly, statistics are derivatives – not drivers – of market behavior, in the same way, liabilities and assets are opposites (read “Rich Dad, Poor Dad“). It is unwise to apply a derivative (statistic) as a driver for market decisions. All experienced entrepreneurs know that.
So, my answer depends on whether you reference the actual or supposed workings of VC.
In today’s VC
In today’s venture capital ecosystem, every GP must have the relevant operating experience, with the emphasis on relevant. Relevant experience as that of an early-stage CEO in tough times, still producing success.
Many GPs can only flaunt experience from behind the confines of a large brand name conglomerate, rather than the experience of an early-stage CEO, investing his own money, defining a unique company ecosystem, living on borrowed time, raising a few rounds and selling the company. The VCs with that level of operating experience are hard to find, and so are their successes.
Why is VC operating experience important:
1/ Many venture-funded companies today are built with what I coin as the subprime VC model. Amongst many things it means founders need to prove a lot of technological capabilities (see my Khosla reference) before they see an investment dime, and when so, usually receive too little money to hire an experienced CEO. As a result, the board (of investors) runs the start-up, and thus their relevant operating experience becomes pivotal to the success of the startup.
2/ Relevant operating experience matters, not just any operating experience. Successful startups rely on a clear definition of a unique ecosystem (with divisional expenditures and conversion rates). The last thing an entrepreneur needs is a group of investors who can barely deviate from their business school thesis to meet reality and a world that is in flux.
3/ GPs need to be entrepreneurial to recognize and weigh one. The success of a technology startup is not just dependent on how cool the technology is but requires an operational assessment to figure out whether the business model is sustainable, and whether the application of that technology to a demographic makes economic sense. Operating experience is crucial to validate the combined value of operations and innovation.
I can name probably a hundred other reasons, but that would extend beyond the artificial limit of this blog and your patience.
In new VC
In a new VC structure, I would argue for a more balanced makeup of economic managers and operational managers. But that structure can only work when all GPs share responsibility for every deal, rather than today’s norm of every GP managing his subset of companies within the portfolio. Many more things need to change for VCs to accurately calculate start-up risk, snippets of which I’ve covered elsewhere in this blog and will cover extensively in my upcoming LP seminar “The Inconvenient Truth of Venture Capital.”
Alignment with the entrepreneurs
So, until we change the fundamental workings of VC are we bound to hire GPs with relevant operating experience, those that combine that operating experience with the ability to accurately calculate upside risk and align with the entrepreneur.
But a VC firm without relevant operating experience is a risky investment (for LPs) and the wrong strategic partner for the entrepreneur. The significant difference between Private Equity and its sub-class Venture Capital is that the latter can create massive returns, albeit with GPs that are capable of recognizing a diamond-in-the-rough and performing a bit of heavy lifting when needed or desired; by applying experience and influence.
That, as an operator, makes Venture Capital so much fun for me.