A Little Knowledge: Not So Dangerous

In 2007 there were 3,914 venture capital transactions, and of these, about 1,300 were new deals. There were probably more, but this is the number that was reported by the venture outfits that participate in the PricewaterhouseCoopers/ National Venture Capital Association MoneyTree survey, so it’s a good proxy for national activity.

Here’s what’s amazing about this number. How many times have you talked to a venture capitalist, or for that matter an investment banker or private equity investor, who said, “We’ll see about 2,000 deals this year and invest in perhaps five,”

“This suggests that last year’s nearly 1,300 first time financings required investors to look at nearly 3 million business plans.”

Now that’s picky.

But here’s what I don’t quite understand. How can professional investors look at nearly 3 million plans, and find so few successes? Just 130, if you use the common VC metric of one bona fide success for every 10 investments.

And while I don’t quite understand this phenomenon, I have a theory. The truth is, most professional investors know too much. And this knowledge is what keeps them from finding and investing in some incredible companies.

It’s more than just raw knowledge, and it’s more than just domain expertise that I’m referring to. Really, it’s an investor’s role in the domain. That is, if you are the go-to guy or gal for say, medical devices, you go to all the right conferences, every consulting and accounting firm with a medical device practice knows you, and all the board members and chief executives of medical device companies know you. And because of this the go-to guys get fed deals with all the same biases, and get input from all the same experts.

This doesn’t limit their success per se. It does however have them saying no to transactions that they should perhaps really be saying yes to.

And in a nutshell, this is how we approach private equity. Yes, we know quite a bit about banking and structured finance. But there’s a world of opportunity out there in a wide range of disciplines. We don’t feel we need to know everything there is to know about them. What we need to do is spot the entrepreneurs who can operate effectively in them, and have the guts and tenacity to see their vision through.

It’s a formula that works because it creates a partnership where two parties aren’t trying to run the same business. And it’s worth keeping in mind when the go to investors turn your business plan down flat.