In a recent Wall Street Journal article, Harvard Business School senior lecturer Shikhar Ghosh shared that the prevalence of failure in the world of venture capital is much higher than what’s reported.
Ghosh’s research indicates that as many as 75 percent of venture-backed companies never return cash to investors, with 30 to 40 percent of those liquidating assets where investors lose all of their money. His findings are based on research of more than 2,000 venture-backed companies that raised at least $1 million from 2004 to 2010.
Unfortunately, I’m no stranger to those statistics. In the late '90s, I founded EC Cubed, a B2B e-commerce software platform company. Like many other founders, the proverbial door hit me on the you-know-what at the hands of the VCs who invested $50 million to rapidly grow the company. While that was extremely difficult, what was even more painful was watching the company collapse soon after my departure, despite the capital infusion.
Such tales are rarely bragged about. In fact, Ghosh tells the Journal that VCs “bury their dead very quietly.” The deceased are quickly removed from the portfolio companies section of websites, never to be spoken of again.
The success rate of private equity firms isn’t much better. Money doesn’t guarantee success; only effective execution can deliver that goal. I believe improving the odds for venture-backed companies requires better execution.
It goes without saying that private equity investments aren’t for everyone. Reaping mega rewards means taking mammoth risks, and PE investments often demand long holding periods for the turnaround of a distressed company or a liquidity event such as an initial public offering or a sale to a public company. Private equity firms invested more than $144 billion in 1,702 U.S.-based companies in 2011, according to an analysis by the Private Equity Growth Capital Council. Some of the biggest investors in the PE market are public pension funds, many of which have seen sub-10% returns.
I used the term “odds” earlier to draw upon the analogy that more times than not, the strategy employed in the investments made closely resembles that of gambling--or, for those who are more innocent, wishful thinking. A play on probability: The theory that in a numbers game, some will win and some will lose, is not an acceptable approach, especially when fund managers’ fees can reach in the millions while investments may result in massive losses.
Financial Analysis vs. Operational Capabilities
Inherently, I am a self-admitted risk taker by the entrepreneurial blood that runs through my veins. However, I have always managed that risk by conducting extensive due diligence in advance of all strategic decisions I was faced with by taking measured, calculated, and operationally sound steps to ensure I had all the intelligence required to effectively execute as needed based on my choices in order to run my business.
While the venture capital industry has changed a great deal since the days of Georges Doriot, founder of the American Research and Development Corporation, portfolio management styles have not. The industry still places the greatest emphasis on financial analysis versus operational capabilities.
While the financial details are crucial, they do not contain enough forward-looking information to understand, track, and govern the venture performance of today’s ever-changing market brought on by operational challenges and swings.
In today’s increasingly unpredictable business environment, there are a number of operating difficulties that must be addressed. Some of the most critical are:
- Accurately evaluating growth potential, while balancing new innovation against operational execution.
- Developing sustainable processes to reach or exceed revenue growth goals, cut costs to preserve recurring dividends, and protect top- and bottom-lines for portfolio companies.
- Implementing strategies for building sustainable brand recognition, in concert with building brilliant management teams.
- Demonstrating progressive, provable, repeatable results that will sustain the firm today and tomorrow.
- Creating visibility among boards and investors of ongoing operations that provides perspectives needed to understand how to guide portfolio companies.
Establishing specific objectives and applying reliable performance indicators are keys to a manageable process.
To that end, great benefit could be realized by portfolio managers using transparent operating blueprints that connect the dots between financial reporting and actual business operations in order to accurately represent such information across their holding companies.
Why create an operating blueprint? It provides two strategic enablers:
- 360˚ Enterprise Models (business, process, organization, technology, etc.), provide the ability to visualize end-to-end business goals and execution strategies before beginning costly and often irreversible strategy implementations. These models create the opportunity to ask “what-if” questions and test scenarios that help vet problems and issues early on.
- Impact Analyses and Scenarios provide the opportunity with which to alter factors, create multiple output scenarios, evaluate the end-to-end impact of each scenario, and arrive at an optimal solution to address or solve a problem.
Properly implemented, operating blueprints allow fund managers to:
- Maximize ROI at an earlier stage in the fund lifecycle of each portfolio company, and collectively across the entire fund.
- Focus on long-term vs. short-term goals to ensure that the life expectancy of a portfolio company allows it to deliver more than just a one-time target.
- Increase transparency between a portfolio company and the venture fund.
- Bring large-cap business process improvements to the small-cap mindset of many venture portfolio companies.
- Prioritize and guide improved performance, value, and sustainable growth.
The Road to Success
Clearly, new ideas, strategies, and management tools are essential as the capital markets continue to evolve. In today’s volatile market, the success for a new venture is often driven by its ability to recognize significant challenges and immediately identify the strategic imperatives necessary to address, survive, surpass, and thrive despite them.
Accomplishing such goals requires new organizational structures, creating and sharing new kinds of business knowledge, understanding emerging global socio-economic models, and developing repeatable transformational processes. Such an approach within the fund management structure of venture-backed companies will allow those companies to reach their full potential.
By removing the guesswork and emotion, this fact-based and methodical approach allows entrepreneurs/management and institutional investors to come together and collectively work toward the same goal of improved business execution, which equals improved shareholder value--and that’s something everyone can agree on.
[Image: Flickr user Jon McGovern]