Do it, run it, teach it, or own it – that’s what venture capitalists believe in, says Yinglan Tan in ‘The Way of the VC: Having top venture capitalists on your board’ (www.wiley.com). The relationship between the venture capitalist and the entrepreneur is a lot like tango dancing, he analogises. “Just like a pair of tango dancers, VCs and entrepreneurs must understand each other’s roles, coordinate their moves, and work with the same expectations.”
Stretching the comparison, the author finds that venture capital is in fact a game of three – ‘it takes three to do this tango.’ He explains that, despite the common belief in entrepreneurial circles, VCs are not generally investors in their own right; they are highly specialised financial intermediaries, investing funds committed by their investors (the LPs or limited partners) in risky projects and monitoring the fund recipients on their behalf.
“In this context, the managers, monitors, and investors (or, in VC terminology, the entrepreneurs, general partners or GPs, and LPs) are highly dependent upon each other. In this dance of imperfect information, subtle influence principles play an important role.”
VCs and chefs
Venture capitalists are like skilled chefs, reads another analogy, in the intro to the book. Their dishes – the successful companies in their portfolios – are most valuable when the firms remain small and retain their own distinct style, Yinglan notes.
“When a chef tries to mass-produce a menu item, the dish loses value – scaling a batch beyond its ideal size degrades its quality. Likewise, when partners of VC firms take on too many deals and overstretch themselves with too many companies to look after, they can no longer add sufficient value to each portfolio company.”
He observes that venture capital investing has grown from a small investment pool in the 1960s and early 1970s to a mainstream asset class that is a viable and significant part of the institutional and corporate investment portfolio.
Recent reports, however, speak of sharp fall in venture investments into US start-ups, ‘to the lowest level since 1997, with declines spread across all sectors including software and green technology’ (www.reuters.com). The Indian scene seems to be different; VC firms have begun to increase their pace of investments in the fourth quarter making 42 investments worth $265 million – significantly higher than that during the same period in 2008 (23 investments worth $102 million) as well as third quarter of 2009 (19 deals worth $74 million), as per a recent study by Venture Intelligence and the Global-India Venture Capital Association.
On the general confusion in the usage of phrases such as venture investing, buyout investing, and private equity investing, the author clarifies that private equity, strictly speaking, refers to an asset class made up of investments that are not publicly traded. “Venture capital is a broad subcategory of private equity that refers to equity investments typically made in emerging companies for the launch, early development, or expansion of a business.”
Three techniques
The book summarises the ‘winning techniques’ of star VCs in three statements. One, follow the romance, not the finance, because VCs love to build great businesses. The ultimate joy of a VC is in helping and seeing entrepreneurs realise their dreams, Yinglan reminds. “VCs look for entrepreneurs who love what they do and who are very good at doing it.”
The second winning technique is to build a company around the entrepreneur. And the journey, despite its ups and downs, can succeed with passion, dedication, perseverance of the team, and some stroke of good luck, the author guides.
He cites an apt quote of Boon Koh, managing partner of iGlobe Ventures, thus: “The venture capitalist is a mentor to the CEO of the portfolio company. This is analogous to a coach training an athlete. A VC is most effective when working with a coachable CEO. The challenge of a VC is to take the vision of an entrepreneur team and to work with this team to build a global sustainable business.”
Winning technique number three is to source for deals in a densely innovative geography. Some forms of innovation disrupt, destroy, and make obsolete established competence; some others forms refine and improve, with incremental effects. Different kinds of innovation require different kinds of organisational environment and managerial skills, Yinglan instructs.
He adds that breakthrough innovations tend to be disproportionately developed and brought to market by individuals or new firms, even though the ideas behind the breakthroughs originate in larger firms or universities that do not exploit them because of their bureaucratic structures.
“The potential for stimulating breakthroughs is greatest among individuals who have prior experience in relevant technologies and insight about fresh roles for existing inventions and technologies, and who have the energy and means to act on their insight.”
The author, therefore, urges entrepreneurs to position themselves at the intersection of markets and technology, or at the convergence of two apparently separate markets. An example for the latter is new online video, as a convergence of wireless mobile devices and Internet video. “Live content being posted by a mobile phone to Internet can serve extremely relevant ads, which in turn allows the content provider to monetise traffic.”
Pitfalls to avoid
Yinglan warns entrepreneurs of likely pitfalls, such as overconfidence, and concealing skeletons in the closet. The former can translate as overly optimistic projections, which end up ruining the entrepreneur’s credibility. “Investors rely on credible financial projections, not expectations. Unless your assumptions on future earnings are backed up by credible sources do not bring them up.” And, on the latter, Yinglan counsels entrepreneurs to own up to past and existing problems rather than hiding them.
Instead of depending on the entrepreneur’s CV, the VC has to judge the entrepreneur through proper interview techniques and observation of body language and thorough reference checks, the author advises. “Open-ended and provocative questions, acting dumb or confused, and intentional moments of silence often elicit more information than intended to be given by the entrepreneur. Sometimes, what is not said can reveal more than what is said,” reads a helpful tip in this regard.
Recommended read for growing entrepreneurs.
