Sunday, December 9, 2007

Who are those guys? What makes a good VC.

I want to begin to tackle my original topic of interest, i.e. where is the VC business heading in the coming decades. I thought I'd start out be defining the tasks a VC performs, i.e. what skills make one VC better than another. The fact is there probably is only one ultimate measure of a VC that counts --- return on invested capital. I’m not trying to dispute that. But what are the characteristics of a VC that will lead to a good return in the end?

I’m going to organize this somewhat chronologically through the process. And I’m focusing on skills and tasks along the way. Here’s the outline:

1. Finding Deals
2. Evaluating and Picking Deals
3. Executing an Investment
4. Managing and Growing the Deal After Investment
5. Finding a Successful Exit

One can assume that focus, intelligence, integrity, fairness, responsibility, and good communication skills --- these are all valuable and assumed across the board. Finally, I have no gender biases and will use the male gender for simplicity. A female VC can certainly be as good or better than any male VC.

In this first posting on this thread, I’m going to address just those Step 1 skills. Other steps will follow in succeeding postings.

Step 1: Finding Deals

For a venture fund to be successful, it must have a rich deal flow. Garbage in, garbage out… as the saying goes. And every deal presents a different mix of characteristics. The fund needs to see lots of possible deals, ideally all with the fundamentals in order: solid management, strong technology, addressing big markets and with barriers to entry. There is no such thing as a venture fund that invests in every deal presented to it. The venture business is a sifting business. The better the selection, the better the investments that will result.

Therefore a successful VC must either a) get a lot of deals referred to him by colleagues in the field or past associates, OR b) get out there, see a lot of deals and maintain a high profile.

In subcategory a) are those VCs who have a great deal flow coming to them naturally by referrals --- I believe these are rare birds. They are usually extremely successful VCs from the most prestigious funds. We all know a half dozen names of superstars in the field. The best deals frequently come directly to them. That is a result of their success up to now, not the cause of it. Sitting back and waiting for the deals to come to you isn’t something to emulate. I do acknowledge that some superstars are surrounded by a great support staff who often go out and do the legwork for them. But I’m talking here about how you become a superstar, not how you act after you are one.

The second subcategory b) “get-out-there” path favors a personality that is friendly, helpful and engaging. It definitely does not favor arrogance or reserve. Entrepreneurs are more likely to want to work with VCs who are approachable and mentoring. Unfortunately, the VC community often draws its players from the most successful leaders in business and these are frequently very egotistical people. In my opinion, this is counter-productive to getting a good deal flow.

Ironically, it takes a lot of self-confidence to invest millions of dollars in a deal where the team is young and imperfect, the technology is new and unproven, the market doesn't even know it's a market and the incumbents in the market are big and powerful. That favors aggression, competitiveness, and single-minded focus in a VC. In other words, it naturally pulls a VC's personality away from what I think are key skills to this stage in the investment process.

Nevertheless, I believe the key skills for a VC are to be visible, approachable, helpful and mentoring. It is possible to hold these skills and still be self-confident and focused. As an aside, I think this also favors former entrepreneur VCs over professional MBA VCs. A VC can be most helpful from a position of shared experience. Entrepreneurs will appreciate that experience.

So I would argue the best VCs are confident, polite guys, who relate to the entrepreneurs out there, who do lots of panels and presentations, are accessible, listen well, and contribute more than just occasional funding but also advice to entrepreneurs. A VC who does all these things, and does them well, will see more and better deals.

Summary Skills for Step 1: Accessible, open, helpful, visible, mentoring, confidence without arrogance

(To be continued)

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