In baseball and venture capital, success is batting .300
In the venture capital business, failure is part of our model. While we prefer that it be otherwise, early-stage venture investing statistics say that we will lose our capital on one-third of our investments, break even on a third and make all our gains on the balance.
While we go into each opportunity hoping and expecting success, we know in advance that our batting average is likely to mirror that of a good major league baseball player – batting around .300.
Certainly, some of our failure reflects failure on the part of our entrepreneurs. However, we own responsibility to our investors for making the bets we make and most often need to acknowledge our role — even if on occasion it’s simply believing in the entrepreneur.
So, here’s the litany of failure in our world:
• Market too early: We bet on an emerging market, and it doesn’t emerge within our investment timeline. Venture investors who bet on renewable energy plays in the late ‘80s and early ‘90s perhaps wish they’d waited a decade.
• Team doesn’t perform: We bet on a team that blows it — doesn’t execute their plan, fights necessary change, etc. Bad judgment about the team we thought could do it, or failure to change management before it’s too late, account for countless missed opportunities to realize an opportunity.
• Bad product: Products (even services) can be exciting, and venture investors can get caught up in the “cool” of a new thing, without doing the critical work required to ensure that enough customers agree that it’s cool and, importantly, alleviates some sort of “pain” they have in doing things the way they did before the new product arrived on the scene. Other bad product-centered decisions include: product takes too long or is too expensive to sell, relative to its price point; product is only slightly better than the competition but needs to be orders of magnitude better to convince customers to take the risk in buying from a new vendor; or the product just doesn’t do what management said it would do.
• Overpaying: Failure comes in a couple of ways here. One is what I call good company, bad deal — the company’s value at exit does not garner the returns that the risk suggested it should. Making stock market rates of returns is not what our investors give us capital to achieve. The other is that the high valuation, coupled often with weaker performance than planned, results in limiting or eliminating access to follow-on financing rounds from other investors (who may be smart enough not to overpay).
• Run out of money: Venture capital funds have limits on how much they can invest in any one opportunity — if we run out of money available to one company before that company achieves milestones that will allow it to raise successive financing rounds, the company and opportunity may be write-offs.
• Weak diligence: Countless venture fund investors have short-cut the market, management, legal or other due-diligence categories and lived to see it bite them. Miss a key management reference check and you may not know that your entrepreneur had a criminal record or a problem telling the truth. Fail to ask an important question to a customer and you may never know why that subsequent reorder never happened.
• Indecisive: We (investors/board) wait too long to make a key change/shift (in strategy, management, etc.). Many opportunities are saved with decisive board actions, but many more are lost for the reluctance to make the right decision before it’s too late to do so.
• Hubris: Many venture investors (as well as entrepreneurs) seem to think they know it all — the smartest ones (on both sides) I’ve met know just how much they don’t know. Betting on new sectors and technologies can be rewarding if you’ve got the chops to play. And VCs can be very good at getting up the learning curve quickly enough to take advantage of an opportunity. Alas, venture investors can get caught up in thinking they know enough and learn very painfully that they knew too little.
• Inability to control: VC investors are most often minority investors in businesses. Though we will have certain protective provisions and rights to approve, ultimately the entrepreneur drives the business. If we and/or the company’s board have not structured our relationship as one that is sufficient to influence, or push, the management team to act, then we’ve failed to do our job for our investors.
I once heard a major league pitcher saying that failure wasn’t throwing a bad pitch in a given situation — it was throwing the same pitch in the same situation. And so it is with venture investors.
Michael Gurau is president of CEI Community Ventures, a Maine-based venture capital fund that operates in Northern New England. He can be reached at firstname.lastname@example.org.