Sean Park Portrait
Quote of The Day Title
The Web will own every bit.
- Kevin Kelly

Spotting the losers.

When speaking to start-up investors about their track record most of the time the conversation revolves entirely around the investments they have made in the past. The winners, the losers and why. More rarely do people talk about the investments they didn’t make. This is understandable for a number of reasons, one of the most important being there is usually no obvious record to fall back on and there is no way to short bad start-ups. So one relies on the investor keeping track of the investment opportunities they looked at and passed on, and further keeping tabs on how these companies did. Not many investors do this – at least not publicly, one (great) exception being Bessemer who with great humor points out their heroic misses – opportunities they declined that turned out to be home runs – in what they term their ‘anti-portfolio.’ But it would also be interesting to see a record of the deals an investor didn’t do that failed. But this is even harder (if one is to avoid noise) – even a small, relatively new investor like us sees hundreds of proposals and even this depends on what one considers as having ‘seen’. Is it an email in passing saying XYZ is raising money, would you like to look? Is it spending a few hours going through an executive summary / pitch book / website finding out more? And it is also important (if this information is to be meaningful) to qualify why the investment wasn’t made. Is it because it didn’t fit a certain sectoral or geographic investment criterea? ie Good prospect but not for us. Is it because of a conflict with an existing portfolio company? ie Good idea but we like these guys better or they were first in the door and now we’re stuck. Is it because of apathy or lack of resources (time, money)? ie Good idea but just can’t focus and isn’t top of the list? Or is it because, well it’s just not a very good opportunity? ie Mediocre or downright bad idea.

In order to have the discussion, an investor needs to keep a record of all of this. How many do? We are trying to – or at least have plans to do so – but I’ll admit it’s harder than it sounds. It’s not something that generally gets anywhere near the top of a priority list, when the days are filled with making and managing the investments you do make. (And when you are trying to raise capital and/or keep existing investors happy or informed if you are a professional.) Don’t get me wrong, it’s not rocket science and I think it probably comes down to spending a bit of time and energy upfront to put a workflow in place to be able to capture and manage this information efficiently. And to be truly useful, this record needs to be ‘timestamped’ and auditable: we all suffer from hindsight bias. ie We definitely would have invested in Google given the chance, and obviously we passed on Webvan….

OK, fair enough, but why is this important? It’s because I think knowing which investments (and why) an investor didn’t make, and comparing these to the ones they did make, is a much better way to analyze their skills and approach. I think this is true in any asset class, only in most (all?) others it is practically impossible to do the kind of analysis I describe above if they are a long only investor (private equity perhaps being the exception.) Of course for long/short hedge funds this type of thinking is embedded in their performance.

Nauiokas Park is too new for this kind of analysis to be relevant but I was thinking about it in the context of my prior angel investing experience. I didn’t keep a complete record but there are a few deals that come to mind, two of which I was fortunate enough to blog about before the outcome was known, one after (discount appropriately) and so are public record. Hopefully you’ll trust me on the other two.

The first example is a company called SpiralFrog which is now the poster child for the second wave of bad ‘internet’ investments. I was approached in early 2006, through my Wall Street/City network to look at this, as people new I was interested/knowledgeable about “tech” start-ups and had had some success as an angel investor. When I saw the prospectus (and yes it was a prospectus) and looked at who else was involved as investors, I was immediately suspicious: this wasn’t a nimble start-up, it was packaged like a Wall Street deal – the scale and approach were way too heavy. Looking into the plan and the projected financials it just got worse. I passed and when they launched to considerable fanfare, I wrote this in September 2006 and followed up with this a year later.

A second is Monitor110 – great post-mortem here by Roger. This one I didn’t have a chance to invest in but I would have passed. I admit I hedged my bets a bit with this post, but was skeptical of the business model (and unsure of the product.)

The third is Powerset. What attracted me was the great team they pulled together and my conviction that semantic technologies were going to become increasingly important and valuable. I didn’t directly have the opportunity to invest but was one degree away and think I could have if I had agressively pursued.

Zopa is the fourth. I was approached by a friend when they were raising their initial outside round. I loved the idea but didn’t think it could get traction – at least not enough, fast enough to disrupt the market it was targeting, especially given how free and easy it was to get credit (something I new about…) I think I was right then. But I still love the concept and would be open to taking a closer look again in the future should the opportunity present itself. My focus would again be on understanding whether or not they can scale and whether or not the business model is optimal.

The final example is Skype. I didn’t directly have the chance to invest, but again at one degree of separation I could have tried. That said, I’m pretty sure had I been given the opportunity I would have passed: I didn’t see (until everyone had figured it out) how it could be a good investment despite loving the product. I’ve changed my mind and if I were running a big private equity fund, I’d definitely be trying to run my slide rule over them to see if I could make eBay a better offer than the public market.

Good investing is about managing your failures, your losing trades. The best way I know of doing this – whatever the asset class – is working hard to figure out what could go wrong before putting on the trade. (I guess it’s the bond trader in me…) There is always something that can go wrong. If it is big or likely enough you should pass. If not, by having a clear understanding and focus on these risk factors, you give yourself the chance to adapt and/or mitigate before its too late. This is especially true in venture investing as many risk factors in these companies tend to be endogenous; obviously if your basic premise turns out to be wrong that’s tough (but not impossible) to mitigate and sometimes it doesn’t work out. But by actively knowing what is going wrong and why at least you can avoid throwing good money after bad while also knowing when the odds are in your favor and you should double down.

Reblog this post [with Zemanta]
  • Sean,

    In terms of having a system to track this stuff, I think you could get a long way with off the shelf (or better still of the SaaS) CRM, perhaps with a few extra fields added. The entire process has a lot in common with evaluating technology, and I recall many struggles around systems to do this (and syndicate what was going on to stakeholders), where far too much time and energy was spent on having something 'workflow' based rather than having something relationship based (which is after all what CRM systems are there for).

  • Thanks Chris. We are building a database (using Filemaker, at least for now) to track and manage our investment pipeline/radar. What I was thinking was to add records to this to encompass the entire deal flow, through to investment or (in most cases) not. As we have now constructed it, each company has an associated status (monitoring, reviewing, pending decision, etc.) - I was thinking of expanding this to include a 'pass' category and adding records to add colour to this as to why we passed and when. Ideally each company record would be updated over time with new information (new funding, exits, dead pool, etc.) All this is relatively easy. What is harder is to get everyone (including, especially me) to maintain this database and keep it updated. I've not given it much thought, but I think some sort of alerting algorithm would be ideal - auto-generating a daily or weekly 'to do' list. The nice thing about the space we are in is that real-time is measured in weeks not seconds, so should be manageable even with a relatively large (100s or 1000s) pool of companies to monitor.

    Ultimately (when we can afford the time and money), I want to build this into a web app. I have the design vision in my head, and while I'm not sure you could retire on it, I think such a platform could be commercialized (tangentially to our use case, can't say more now.)

    Interestingly, early on we worked in parallel with Filemaker and Salesforce to see which would work better (I thought Salesforce would win) and rolling our own using Filemaker clearly came out on top.

  • I'm curious how what you're building would compare to toolset in Angelsoft.

    While some of the "Group Management" and "Deal Sharing" tools aren't necessarily appropriate for VCs, surely the Deal Management and Company Relations tools would be.

  • Good point Jed - and a reminder that I've been meaning to have a closer look at Angelsoft.

  • Looks like Angelsoft could help you with the pipeline but not the radar. I like the idea of tracking "no deals" as well as deals.

    You have to reduce the barrier to keeping the radar bit up-to-date or you won't do it - I'm reminded of the way you can update TripIt by just forwarding your booking confirmation to them.

    It would be possible to build an app where you just forward a blog entry, a tweet or an email and the app has the smarts to append the new information to the correct startup. You'd just need to add a status field ("new funding", etc.)

    You could even automate it to the extent that if you give it an OPML file it attempts to associate new RSS notifications with your tracked startups without human intervention. Loving it.

blog comments powered by Disqus