Venture Business Dogma

Venture Business Dogma: People, People, People...er, maybe not.

I know this may be heretical and maybe blackball me in the venture industry…but I gotta be me. And I use the word “heretical” by design because this topic can devolve into a religious argument. Many investors swear by the venture capital maxim that the three most important things in making an investment decision are people, people and people. I’m not sure that’s the case anymore.

My primary thesis is that the scarce resource in the current generation of the company startup ecosystem is finding a product or service that satisfies a significant and growing economic demand materially better than the alternatives (both direct and indirect alternatives), and creates incumbent competitive advantages, i.e. the nature of the product or service is that the strong get stronger, intrinsically.  When that scarce resource is found, all the other resources, including the right people to build the business will flow to it. In other words, optimize the equation around the product-market axis and then solve for the other variables around it over time.

A related maxim that maybe explains it more plainly is that these investors would rather back an “A” management team with a “B” business plan, rather than “B” team with an “A” plan. I think that’s outdated. There are too many entrepreneurs and too many investors around the world all introducing innovations to satisfy various demand pools all the time. Twenty years ago (or maybe even 10 years ago) the “A” team had time to retool their product or service and find the unmet demand and satisfy it. But now everything happens so fast, in part due to the Flat World, in part due to incredible influx of capital into the venture asset class, that the “A” team doesn’t have time to retool, or the more likely outcome is that if they do re-tool then the capital that backed them on their earlier iteration of the product/market plan is rendered worthless in a "re-cap" financing (I'll leave it to Brad Feld at Ask The VC to explain a "re-cap").

I don’t know if this is an apocryphal statement or not, but Don Valentine, legendary VC at legendary firm Sequoia, supposedly once famously said: “I want to invest in companies addressing markets that are so big that even the management team can’t get in its way.” I am an apostle of that church. I describe it as I look for opportunities where there is potential for the demand to just SUCK up the product or service like a wet-vac, mess and all.  When you find that situation, all the other issues become second-order; still important, but second-order.

As an investor, the biggest hit I ever had was one of these. I pursued an investment in a company that was out of favor among the “smart VC set”.  They had met with virtually everyone in the industry and no brand name firm was stepping up to lead it, and the partners at my firm initially were down on it. We killed it once, because of a combination of management team, nascent market, regulatory, deal structure, geography and syndicate issues. I brought it back up a few months later and everyone eventually got comfortable enough with it and supported me to do the investment. It turns out everyone was right. There were a lot of very messy issues, including having 4 different CEO’s in the first 5 years after we invested. But the demand for what they were delivering proved out to be HUGE, and they had the technology and infrastructure to deliver it better than anyone else. It was those two things that I focused on in my due diligence and compelled me to stick with it even though many other elements of the opportunity were sub-par.

When we invested that company had done about $1 million in revenue in the trailing twelve months. Five and half years later it did $200 million in revenue in the trailing twelve months and $70 million in EBIT and had a market cap of $2 billion.

That company was kind of like a sausage factory: it wasn’t pretty to see it being made but what came out the other end was damn good. To me that was a great experience of optimize your equation around the product / market axis and then solve for everything else over time.  It certainly doesn't always work, and I absolutely don't want to minimize the importance of great management teams (especially since I'm currently on the operating side of the business), but that's the way I'm seeing the startup world right now.  It definitely influenced me in my choice to pursue the operating company opportunity I'm doing now -- I think we have one of those opportunities where the demand is ready to suck up our offering like a wet-vac.  I'll be blogging more about that in the near future.

Comments

[Jason Starr]

Hey Dan...if you haven't read the "Jockey vs. Horse" paper by Chicago GSB professor Steve Kaplan (or seen his presentation), check it out. He's done some pretty impressive research that backs up exactly what you are saying. He studied a bunch of successful VC investments and determined that the idea or core line of business does not change...though the leadership team is changed quite often. There's a link to the full paper at http://www.sifr.org/PDFs/KaplanSensoyStrombergAug2007.pdf and Matt McCall has a link to the PowerPoint presentation at http://www.vcconfidential.com/2006/04/horse_or_jockey.html.

Best,
Jason

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