Healthcare Venture Capital

What They Don’t Teach You About VC In Business School – Part 1

In healthcare on December 5, 2011 at 9:57 am

During my MBA, I was lucky enough to be taught by some of the great practitioners and researchers in the field of venture capital, including legends like Bob Higgins, Bill Sahlman, Josh Lerner, and Felda Hardymon – the All-Star team of VC in my opinion.

However, there are a few things that weren’t discussed openly in the hours of case studies and classes I took on entrepreneurship and venture capital.  Today I will tackle one of them: career planning in venture capital.

Rob Go of NextView Ventures perfectly captures this in a post today over at his blog discussing what it’s really like to be a VC – one of the few very realistic and pragmatic perspectives I have read on the topic. As Rob states:

 VC is a risky career path. It’s a lot of fun for a couple years.  But after two years, even if you were an operator before, your skills become stale and you are realistically not going to be as good at your former craft as you were before joining venture.  Your hire-ability is still pretty high at that point, but in years 4-6, you start running out of options.  It’s also on those years that you face the pressure of establishing yourself as a partner in the firm and hope to get meaningful economics in the fund.  As as I’ve blogged about before, the deck is kind of stacked against you.  Here’s why: a typical VC will do about 2 investments per year.  A principal or junior partner might be on a slightly slower pace.  So in years 4-6, you are realistically responsible for ~3 investments.  This is also the time when your partners (or other firms) are making the decision to make you a meaningful partner in the fund. So, in a way, your prospects as an investor are largely linked to these 3 investments.  Those odds aren’t great, in a world where most startup companies fail and only about 20%-10% drive a meaningful return to the fund. Do you really want to be evaluated on those 3 shots on goal, when a) it may be way too early to tell if any of them are winners but losers are usually identified more quickly, b) broad market fluctuations have a huge impact on the success of these companies, and c) most VC’s will agree that there is a huge amount of luck involved in this business?  Tough odds.

This is critical – as a young partner or principal in your firm, you will be judged on the outcome of your first 3 to 5 deals.  Indeed, I will sharpen that and say that in this era of shrinking firms and a shrinking VC industry as a whole, you will likely be judged on the outcome of your first exit.

As the data shows, somewhere between 57% (healthcare) and 76% (IT/Internet) of investments return less than 1x invested capital according to Cambridge Associates numbers which I analyzed in a paper last summer with Bruce Booth from Atlas.  The data also shows that median time from first investment to exit is between 6 and 9 years.

Sorry to say it, the deck is stacked against you.  But it doesn’t have to be if you think through it carefully from the outset.

If you are a young partner at a firm, how do you put points on the board early in your career and in a timely fashion?

Of course you do all of the obvious stuff: source great companies, network constantly, make yourself valuable to other partners and portfolio CEOs, and be first in and last out every single day. In short, earn their trust.

But the best to prove your value is with mark-ups or early winners. Inside the hallways of venture firms, money talks.

You do this most easily by investing in “momentum stage” companies – define momentum as you wish – but typically it’s companies having revenues or in a market that is frothy enough that a 12-24 month mark-up from a new investors is possible.

This is of course easier said than done. But it probably excludes filling your bench of 3 to 5 deals with early stage, science-heavy investments or academic spinouts that are years from market or will necessarily take inside-only capital for several years to come.

In healthcare it might mean leaner early stage, asset-light biotech with near term milestones or revenue stage HCIT, medtech, or services. In internet and IT, it probably means either finding a category defining game-changer (high risk) or more likely by investing in a company with revenue or traffic traction of some sort.

It’s much harder to prove your value as a partner after 5 years at a firm by going back to them and showing an unrealized portfolio full of companies that have done tranched insider financings or flat rounds. Even if those companies are largely going according to plan, that’s probably not good enough to get you promoted or to build your track-record such that you can take it to another firm.

If you are 3 to 5 years in and don’t have some of these momentum stage companies in your portfolio and you still haven’t had an exit, then stop reading this post and go find a great company with momentum now.

Career planning in VC is about portfolio planning from the outset. You can never time markets, but you can enrich your odds by thinking through.

Thanks Rob for inspiring me to finally post this.