Would a Dart Board Provide better VC Returns?

For those of you that are regular visitors at ProfessorVC, I apologize for the long hiatus over the holidays and beyond. I know there are at least a few of you as I received several emails this week along the lines of "no new posts since November???"

Well, I'm back. Was amused to read about Right Side Capital this week. They have raised a fund to provide seed funding of $50-$250K to 100-200 start-ups. Rather than going through their networks or targeting specific sectors for deal flow, they are going to rely on an algorithm to select companies. The formula will be based on the founders' experience, schools they attended and other background information to gauge the likelihood of success. This certainly gives new meaning to "drive by investing" which became popular in the late 90's....

My first reaction is incredulity that limited partners would buy into this idea. Of course, when 10-year returns for the entire venture capital asset class is about to drop below zero, drastic measures may be in order. Seed stage investing is all about the team, so there may be something to this idea. For firms that don't have access to the most successful entrepreneurs, trying to predict an individual or individual teams success rate based on experience, personal attributes, intellect, etc. might very well be a good way to find some promising first time entrepreneurs. This is not far from the Y Combinator model, except they put a lot of time and energy into working with the entrepreneurs. With 2 or 4 new investments per week that Right Side is projecting, it will be challenging enough to remember the names of the entrepreneurs in their portfolio, let along help build companies.

This got me thinking about the debate over serial entrepreneurs and whether success breeds success or complacency. My colleague, Anu Basu, Director of the Silicon Valley Center for Entrepreneurship at San Jose State, recently completed a paper on this topic, "Does Experience Matter? A Comparison Between Novice and Serial Entrepreneurs" Her research shows that there is a positive correlation between prior founding experience and new venture performance due to stronger and more diverse social networks, access to capital, reliance on collaborators and other factors.

While this is not surprising, it would be interesting to look at returns provided to venture capital firms from novice and serial entrepreneurs. Serial entrepreneurs would be more likely to have larger personal investment in the company, have taken outside investment at higher valuations and possibly less open to taking big "bet the company" type risks.

Of course, given the state of venture returns, perhaps randomly picking from a stack of business plans would provide as good or better results than an entrepreneur selection algorithm or detailed due diligence. I recall that the WSJ used to run a contest in stock picking between investment analysts and selection by darts. The random selection fared quite well against the analysts and now the contest has shifted to readers vs. darts. The darts seem to be doing quite well over the past few years...

Is the Grass Really Greener on the Dark Side?

The spring semester of my Entrepreneurial Finance class starts tomorrow. During the next four months, we will examine over a dozen entrepreneurial ventures from a diverse mix of industries - technology, service, food & beverage, and fashion. We will also look at a variety of financing methods including venture capital, angel investing, licensing, franchising, roll-up, venture debt and my old favorite, bootstrapping. One thing that strikes me every time I teach the course and in my investing activities is how much easier it is to critique someone else's idea than build your own. In addition to the case study analysis, the students also have the opportunity to develop a business model and financial model for a new concept, which always proves a lot more challenging.

I think this same concept plays into what I've seen happening a lot more in the venture community: partners at VC firms jumping back into entrepreneurial ventures. There used to be a fairly standard career path in the venture capital industry. After a successful career in a technology leader (Intel, Microsoft, Cisco, etc.) or one or more exits as a start-up founder, you were enticed to become a partner on Sand Hill Road, or as some call it, jumping over to the dark side. With a limited number of these opportunities and 10-year fund cycles, there wasn't a lot of transition among partners in firms. In fact, most partners that left VC firms either cut back to a non general partner role and/or to personal investing and other activities.

However, over the past 5-10 years, we have seen a lot of changes in the make-up of firms, expansion and consolidation in number of firms and partners leaving to join other firms or more interestingly, to start companies or join other start-ups. I thought about the differences a lot when I spent several years as a venture partner. I had been considering moving towards a full time role as a VC, but decided I enjoyed the company side better and participating as an active member of the team rather than strictly an advisor, coach and board member.

Perhaps, this is partially driving some of the jumping across the table, but certainly the performance metrics of funds and individual partners has also played a key role. An argument can also be made that money remains the key driver and given the increasing competitiveness in the VC business in both raising funds and investing, that start-ups are now seen as the more lucrative route.

I'm going to continue to follow the paths of entrepreneurs turned VCs turned entrepreneurs again and see how it evolves. As an angel investor and start-up CFO, I should have a good vantage point.