Tag Archives: Quantitative

Conversational culture at VC firms

Success in venture capital requires being very good at making qualitative assessments while being good enough at making quantitative assessments. The reason is that startups tend to have limited operating history and hence limited financials, so being able to envision a startup’s future is a more important predictor of investment success. The reverse is true for private equity, where one can accurately assess the extensive and more stable financial performance of a company and thereby project its future with relatively more certainty.

This is a topic that I wrote about in greater detail earlier.

As a result of the more qualitative nature of venture capital investments, successful venture firms tend to have a culture that facilitates the surfacing of these accurate qualitative assessments. This, in turn, requires being able to see a business’ strengths and weaknesses, as well as the likely future paths that it may take, from different perspectives. This is difficult for an individual to do because of human attributes like confirmation bias, where one naturally looks for evidence to support a given perspective while discarding evidence that goes against it.

It’s easier to see different perspectives when you have multiple people around the table sharing their ideas with each other. This requires a conversational culture where people are comfortable sharing their views, respect the views of their teammates, and are willing to change their views when necessary to arrive at the most accurate qualitative assessment of the future. In other words, it requires seeing conversations as a means of arriving at the truth rather than an opportunity to show that you’re right.

For these reasons, successful venture firms tend to have a conversational culture.

Succeeding in VC and PE

Venture capital (VC) and private equity (PE) are two very different asset classes. Although both asset classes invest in private companies, PE invests in more mature companies with a lengthy performance record while VC invests in younger companies with a more limited, if any, operating history.

In PE, since the target companies have an established business model, lengthy operating history, and extensive financials, it’s possible to extrapolate from these to the company’s future. Although the actual outcome will be different than any individual’s projection, the range of projections is likely to differ by a small factor. The range of individual projections is unlikely to be more than an order of magnitude apart.

The target companies in VC have limited operating history and limited financials. That is if they have a business model at all. Sometimes they’re in search of a business model. As a result, the investment decision can rarely be based simply on extrapolating a prior performance record. It requires a qualitative assessment and insight rather than number crunching.

This doesn’t mean that valuation doesn’t matter for VC. It does. But the range of individual projections for a specific company are very likely to be an order of magnitude, if not more, apart.¬†As a result, in VC you can afford to be off by a factor of 2 or 3 on the exact size of the outcome as long as you are correct in your assessment of the order of magnitude of the outcome. In PE, being off by a similar factor of 2 or 3 would be lethal.

As such, the profiles of the types of people who succeed in VC and PE are quite different. In PE, you make money by being quantitatively right. The qualitative direction is pretty clear. In VC, the accuracy of your qualitative assessment is the key driver of returns. You need to be in the right ball park quantitatively, but you make money by being right qualitatively.

Knowing whether you prefer and are good at making qualitative or quantitative assessments is key to knowing whether you’re likely to make a better VC or PE investor.