MONEY TALKS by Andrew Waitman

Single-founder backed start-ups are relatively less successful than multi-founder start-ups in achieving venture returns.

WaitmanHighEdit-111X196.jpgChoosing between the team and the market potential
From SCAN's Print Edition

In my last column I discussed the “illusion delusion” of due diligence, arguing that thin-slicing information about future events may lead to only slight improvements in predictability at best and misleading conclusions at worst. When confronted with circumstances which are enormously complex and massively uncertain, simple rules are often necessary to guide our actions.
Successful venture capital may be one of the most difficult games in business due to the myriad of variables, timeframes, complexities and the unpredictability of people and business. The art of venture capital then is to recognize patterns that provide us simplifying rules or heuristics in selecting and nurturing successful start-ups. Pattern recognition is at the core of experience and wisdom. However, as Heraclitus observed, “one never steps into the same river twice” ─ life’s river flows forward in constant flux ─ requiring constant re-evaluation of the patterns with every new context. In this column, I will discuss one of the most important pattern recognition skills of the venture capitalist: the patterns of successful people.

There are two major camps of venture capitalists: team-oriented camps (Teamers) and market-oriented camps (Marketeers). Teamers believe that venture returns are determined by the quality and composition of the team pursuing the venture opportunity. I am solidly in this camp camp. I believe that if you select the right quality people you dramatically improve the potential for venture returns. My thesis is based upon the premise that quality people will only want to pursue promising, venture scale/dynamic businesses. I will define “quality” in a moment.

When Teamers realize that the market or technology is incapable of achieving venture potential they will adapt, re-evaluate and re-vector into a better venture-return market space. Dave Caputo and the founding team at Sandvine did exactly this and achieved $100 million in revenue in seven years from inception. Celtic House funded the team without any clear product or market direction. The Sandvine founding group speculated, identified and then adapted to a venture market opportunity (traffic management) with a core technology (Broadband deep packet inspection). The investment decision was based entirely on the quality of the team.

In the market-oriented investor camp are the venture capitalists who believe that if you have the right technology/product in the right market (with venture dynamics) at the right time you will achieve venture returns. This camp sees the team of founders and management as replaceable and secondary to identifying the right technology and the right markets. Often this camp’s portfolio companies have higher turnover of CEOs.

Marketeers believe they are good at identifying new market spaces and venture opportunities in emerging new industries, e.g.Internet, Web 2.0 etc. This investment philosophy recognizes that there are geographic limitations. Locating teams with relevant technology and market domain knowledge may require geographic adaptation of investment. For example, when telecom became one of the “hot” venture markets, venture cash flowed into Ottawa because that was where telecom expertise was believed to be.

Your venture investment philosophy will orient your perspective on the areas of due diligence that receive the majority of attention. As a Teamer, I focus my due diligence on the people. And this due diligence involves identifying the patterns of successful entrepreneurs and teams of the past. For example, one pattern I have identified is that single-founder backed start-ups are relatively less successful than multi-founder start-ups in achieving venture returns. A start-up’s executive team’s diversity, capability and cohesion is a key indicator of start-up success. Single-founder dominated companies tend to lack the diversity or experience necessary to manage the myriad of complexities encountered in the start-up world. This is not to say Celtic House will never fund single-founder start-ups, however it is one indicator among a myriad of measures that venture capitalist assess to decide on an investment.

The quality of an individual, like a painting’s esthetic, is a difficult element to deconstruct and is often “in the eye of the beholder.” However, simple rules can help due diligence on teams. Backing entrepreneurs and people with large and impressive networks is a good rule of thumb. A large high quality tribe is a common pattern among successful individuals and a good indicator of their ability to build relationships, judge other quality people, and successfully work with others. Business is about relationships — working relationships, customer relationships and investor relationships. A person’s demonstrated ability to build a large quality network of friends and business colleagues is highly correlated with his or her ability to be successful in business. Entrepreneurs and executives must convince employees to join a risky start-up, persuade customers to purchase their product and attract investors to invest in their company.

Attentive due diligence of people, entrepreneurs, executives, employees and board members is one of the most important aspects of venture investing and it is fraught with difficulty, confusion and conflicting insights. For example, many “celebrity” executives (those who have worked at marquee companies like Google, Cisco or RIM) give the perception of a large and valuable tribe with a wealth of important connections. However scrutiny reveals that many do not have the network, experience or success that their association with such successful companies would imply. It is critical that during the due diligence process that time, energy and effort is invested in determining the real value of the team you are considering. In my next column, I will discuss additional attributes of quality teams including the dangers of “celebrity” executives and how to ferret out the good from the bad.

If you are interested in a useful book germane to these and other important business topics, read Paul Ormerod’s Why Most Things Fail.

Andrew Waitman is managing partner of Celtic House Venture Partners, specializing in early stage investments in high technology companies.

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