Fool’s Gold for Investors: The Dominant Myth in VC and Angel Investing Needs to be Critically Examined
The Illusory Value of the Serial Entrepreneur
By John F. Ince
Over a career as a financial journalist that spans decades, I’ve interviewed a hundreds of investors and entrepreneurs in high tech. I almost always ask them what’s the most important factor in their investment decisions. The answer is so predictable, I’ve become skeptical about it, something to the effect, “We bet on people, not ideas. We’re looking for an intelligent entrepreneur with a successful track record. The idea is almost secondary.”
But can truly great ideas for companies really be separated from the people who generate them? If not, then VCs and angels today are operating upon a myth? It’s fool’s gold for investors. It needs to be critically examined and challenged, because it results is a process that maximizes the clutter of the serial entrepreneur and minimizes the chances that the inspired entrepreneur will be recognized and funded.
It’s a myth based upon convenience–the convenience and relative simplicity of evaluating entrepreneurs’ track records, in preference to the complexities and challenges of evaluating the potential for greatness in their thinking and ideas. If the VCs are doing their job, both as mentors and funders, then the power inherent in great ideas will attract the talent needed to successfully execute them.
To understand why investors choose the convenience of this myth, let’s look at the pressures on investors. First, investors consider their most valuable and scarce resource to be their time. As a result, most, who are in the business professionally, work from a template for investing that enables them to leverage the value of that scarce resource. The question for investors is, “Does that template for investing allow them to recognize and evaluate truly great ideas and entrepreneurs?”
Second, most VCs are answerable to their LPs, who exact high demands in the form of above market returns. To achieve this, VCs look for a minimum 5x return with a viable exit strategy within five to seven years. They play the odds, always looking for the home run that will bail out their losers. Even if four of five investments fail or limp along at break even, the home run will more than make up for it, and make them look good with their LPs.
Now, let’s take a look at the history of the tech sector for the last 20-25 years. If the successful startup track record is so important, and investors are really looking for the home run, how does that jive with history? If we try to pick the the 10 biggest home runs during this period, we’re looking at the likes of Microsoft, Oracle, Sun, Apple, Yahoo, AOL, eBay, Netscape, Amazon and Google. Some might argue for additions or deletions, but for a first cut, it’s a pretty safe list.
Let’s look at the entrepreneurs behind these home runs and ask if they would meet the criteria that investors are using today to screen their portfolio companies? We’re looking at Bill Gates, Steve Jobs, Larry Ellison, Scott McNealy/Bill Joy/Andy Bechtolsheim/Vinod Khosla, Steve Case, Jerry Yang / David Filo, Pierre Omidyar, Marc Andressen, Jeff Bezos, and Sergey Brin / Larry Page. Had any any of them started or run a successful company before their home run? Did any of these entrepreneurs have the kind of successful track record that investors use as their benchmark today? One might make the case for one or two in the list, but on balance none would pass the track record criteria that investors place such emphasis on today. Most of these guys were first time entrepreneurs and all did things differently, and that was part of their genius.
VCs and angel investors are inundated with business plans. Most plans just go onto the heap. Let’s assume that the entrepreneur has done a little homework to find the VCs and angel investors who are interested in their space. From that pool, how can an investor recognize the startups and entrepreneurs with truly great potential? This is the billion dollar question. To answer it, I’m going to start with a gross oversimplification: there are three kinds of entrepreneurs in the world.
First, there are novice entrepreneurs. They’re just learning how the game works. Their networks are small and of limited value. They may have good ideas, but they’re unsure how to present them and to whom. Their understanding of basic business concepts and trends is just growing. They may have intelligence and commitment, but it usually has not yet matured into a passion.
Second, there is the serial entrepreneur. This is someone who knows how the game works. They come equipped with good analytical tools and an extensive network of contacts. They’ve been through the drill before, often several times. They usually have a track record that either speaks for itself or can be sufficiently embellished to create a level of comfort with investors. The overwhelming preponderance of investor bets are place on serial entrepreneurs, because it’s usually most convenient– they’re perceived to be safe bets. Also, serial entrepreneurs are easy to distinguish from novice entrepreneurs on the basis of surface impressions.
But, again, the perceived value of the serial entrepreneur is fool’s gold. Why? In period of rising expectations and markets, betting on serial entrepreneurs can brings result for investors on balance. But in period of declining markets and expectations, like now, this approach is fraught with unanticipated risks. Investors end up with a portfolio of me-too ventures in increasingly narrow and niche markets that seldom achieve the scale necessary to even break even.
The pack trend of betting on serial entrepreneur is, in the broad schema, unfortunate both for VCs and the tech industry in general. Why? Because the entrepreneurial ecosystem become a closed loop that feeds on its own myths and increasingly narrow thinking. In other words, the focus on finding a good serial entrepreneurs blinds investors to the much greater potential in the third category: the inspired entrepreneurs.
The inspired entrepreneur is someone who doesn’t build and flip companies for a living. Sometimes the inspired entrepreneur is someone who has taken a few knocks in the real world and has learned from those experiences, analyzed them and come up with a truly game changing vision for a startup. Sometimes the inspired entrepreneur is just a technical genius. Wherever the inspiration for the startup comes from, it’s usually a once in a lifetime experience.
Inspired entrepreneurs have a feel for fundamental long term trends in society rather than the transient and haphazard movements of markets. They have an uncanny ability to peer into the future with a sense of clarity–integrating widely divergent perspectives and functionalities. They have a healthy level of skepticism for both conventional wisdom and appearances. Their sense of guidance flows internally, from gut instincts that are clearly formed, rather than advisors who are focused on momentary and superficial factors. They have some threshold level of organizational and interpersonal skills, but they have little patience for small minds and limited vision. They are often brusk to the point of rudeness, intolerant of mediocrity, and direct in manner.
Although they understand the languages of many different disciplines, their ideas can often only be understood by a small circle of highly intelligent people. The investors passion for brevity and simplicity frustrates the inspired entrepreneur, whose ideas are usually rooted in complexity that defies facile explanations. This frequently leaves inspired entrepreneurs grasping for resources they need to push ahead with their vision.
The inspired entrepreneur has no intention of doing anything else with their life other than work to make their vision a reality. The intensity of their inspiration creates a level of commitment and passion that keeps them going even after multiple rejections and shifts in the marketplace of ideas. But even the most inspired entrepreneur can only take their commitment so far without backing. Is the cookie cutter approach to investing so biased towards the serial entrepreneur, that “insanely great” ideas and entrepreneurs are going unfunded?
If Larry Page and Sergey Brin were shopping a business plan today, would they get anyone to listen seriously? From hindsight, most investors would say, “Of course, I’d listen,” but would they really? Would investors really have listened to two 25 year old grad students with no startup experience, no revenue model, no tested management team in place, for an app that was perceived to be a secondary add on, in a field that was already crowded with well-funded incumbents?
If an inspired entrepreneur comes to an investor with a startup plan that’s truly game changing, but the entrepreneur just isn’t in the mold of the serial entrepreneurs that investors usually bet on, will the investor give that person the time of day? If the inspired entrepreneur just hasn’t learned to play the game the way VCs are used to having the game played… the attention grabbing elevator pitch … the one page executive summary … the polished powerpoint… the well chosen buzzwords… the highly credentialed management team… will VCs let that inspired entrepreneur in the door and engage in a serious conversation. If the answer to that question is “No,” then where are investors who will back the Amazons, Yahoo!’s, eBays and Google’s of tomorrow?