Beating the Market
If you don’t have an unfair advantage with each investment, you’re no better than average.
My public market investor friends are acutely aware of “the market” in a way that venture folks tend to ignore. Marking your holdings to their current trading values each and every moment of the day acutely brings to the forefront feedback about what is mere beta and what is true alpha excess return above the systematic performance benchmark.
Of course, VCs are also eventually measured against their own benchmarks, though on a firm’s single fund level by vintage year… and it only really counts after a few years after the inception of the fund. So the visceral feedback relative to beating the “the market” just isn’t as acute.
However, as an investor, I push myself to think about it constantly. What edge do I have, both broadly in my career and on each specific investment which I make? On the latter, you can seek an advantage on each investments’ three basic components: sourcing, selecting, and adding value once it's in the portfolio. You’re lucky if you have it on one of those components, especially if more than one. The good news about VC versus public market investing is that these three components give a wider opportunity to be differentiated, whereas in the publics arena “selection” is the only lever to push (save perhaps some activist investors). After all, there’s nothing to source… by definition all public companies are out there for the picking! Though that’s increasingly true in startupland, with Crunchbase, PItchbook, and other resources which VCs use to not just catalog companies but also identify those who are doing well. Even at the earliest stages, data providers like Specter are flagging founders of new ventures before they’re even being started!
So with every aspect of the venture value-chain becoming increasingly competitive, each time I make a new investment I ask myself three specific questions:
Is there a specific and/or unique reason why I am seeing this investment opportunity or have an upper hand given relationships involved to win the deal?
Do I have a specific insight, either hopefully through unique previous investment experience or at least deep understanding of the space or company, which other VCs don’t see as to why this company will be more likely to succeed?
Can I be helpful to the company in some way that will genuinely and materially move the needle towards success?
If I cannot answer a definitive “yes” to any of the three questions above, then I give real hesitations to proceeding forward.
That’s not to say that if it’s a “no” to all three inquiries above that the company won’t be successful. Hardly. Rather it’s just that there’s no way of me having a more likely chance than average. And we know how well the average VC fares. We live in an asymmetrically distributed world.
Conversely, just because you have an advantage, of course it doesn’t mean the company is going to be a success. Most startups aren’t. Rather, it means that the likelihood could be better than average.
Given the above framework, it’s no surprise that VCs that are earlier in their career skate towards becoming domain experts that can yield genuine investment insights derived from understanding. It’s more difficult to have the deep relationships required for a relationship advantage in seeing an opportunity and certainly more difficult to be able to step-function accelerate a company. So a true understanding of a space with unique intuition creates a career stepping-stone advantage. Over time as an investor’s network develops, there will be more opportunities for a primacy on that front. And it’s a separate blog post of how many VCs can truly move the needle on the ultimate success of the company, something we debate internally at NextView all of the time!
There’s the old adage that if you can’t spot the sucker at the poker table, you’re it. Any inexperienced player can of course get lucky early, but over time the market identifies those with a true edge. Recognize when you have an advantage in sourcing or selecting, and be cautious when you don’t.