Saturday, June 30, 2012

Why do we tolerate failure in the VC industry ?

An assortment of United States coins, includin...
I am an Angel investor ; and a member of the Mumbai Angel investors network. I attended a very interesting present day presentation today on “ Patterns of Success and Failure in High Potential Entrepreneurship” by Prof  Ramana Nanda from Harvard Business School .

He had an interesting take on how the US venture capital industry has evolved. He pointed out that historically the entire focus of the VC industry in the US was to aim for the “ home run”. VCs ( and PE fund managers) were paid big bucks so that they could find the one money company which would become extremely successful. This means that fund managers were willing to invest in a lot of very high-risk ventures , in the hope that they would get luck and hit the jackpot by finding the one company which would help them to become billionaires. However in order to find that one company which would become extremely successful, they had to live with the fact that they would have to back a number of failures. In fact, in the USA, it seems that failing has become a sexy thing to do . The US financial industry has marketed the concept of the iconoclastic entrepreneur very well ! It seems that the best path to success is littered with a number of failures – which means that it’s fine if the companies which these financial whiz kids invest your hard earned money in end up failing !

He pointed out that over the last 10 years, people who had invested in the venture capital industry have earned negative returns . VC fund managers have actually lost money for their investors ! I found this quite perplexing. People who invest in venture capital funds are supposed to be savvy , sophisticated financial investors , who were extremely knowledgeable and were willing to take risky bets, in order to earn higher returns ! They were smart and knew exactly what to do with their millions – hand it over to VC who would convert these to billions !

Even more importantly, VC fund managers are supposed to be the blue eye boys of the financial sector - it's only the very bright ones who get the privilege to become fund managers and invest other people’s money ! However, in spite of the fact that they are so smart and so rich, their real life performance has been pathetic.

This raises the  intriguing question - why do we tolerate such poor performance ? Why are we willing to accept such a high failure rate within the financial services industry ? This is not something we would be willing to tolerate in other professions ! For example , we would very unhappy if doctors started making lots of mistakes. We expect our doctors to be experts , and we trust them with our lives , so they can help us to get better. Similarly, we expect VC fund managers to be financial experts , and we trust them with our life savings , so that they can help us to become richer. When the doctor fails to provide us with the right medical care , we are happy to sue him for negligence. However, when the VC fund manager causes us to lose money , we are much more charitable and are willing to put it down to “ learning experiences” !

Doctors have a much harder time making right decision, because they deal with biological systems, which are often unpredictable and complex. Logically, we should be much more tolerant when they make mistakes ! However , our tolerance for doctor’s failure is very low and the knee jerk reflex for why this is so is “ Obviously! When a doctor messes up, it may cost me my life – and isn’t life and health worth much more than wealth ? “ However, if health is really so much more important than wealth, then why do VC fund managers get salaries which are ten times more than we pay our doctors ? Why do we have these double standards ?

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