Venture Capitalism – luck or science?


Over at his excellent blog, A VC, Fred Wilson is bearing his Venture Capitalist soul and offering a lot of insight into his very successful VC firm.     Today, his analyses of why some startups fail sounded really compelling to me in the same way many stockpickers sound compelling.    Yet in the stockpicking world it’s common knowledge that past performance is no measure of the future.   In fact a lot of the ideas about “good” vs “bad” analysts are bogusly based on after-the-fact analysis of records.    Predictions, not after the fact stuff, are what we need to test hypotheses about what works and what does not.

Fred also has this post suggesting VC is not like stocks, but I’m not seeing data to support this.  In fact if he’s right – that the top VC funds can pick a lot more winners than losers – then why doesn’t *all the startup biz flow to them immediately?*.

My working hypothesis is turning into the following ideas:

Winning VC firms are like winning stock pickers – they for the most part are the firms  hat were at the right place at the right time.   The winning record is NOT the product of conscious, clever, consistent application of any sets of rules.    It is simply the product of math – you’ll have a top tier by definition.  

I also apply this rule to my own successes and failures in biz and life in general, though I always catch myself thinking I can “outwit” chance.    I think egos get in the way of good analysis about the world, which suggests a lot less control over things than we’d like to think.    This is still in the working hypothesis stage and I have not reconciled that fact that I can predict with enormous accuracy that, for example, I’ll be drinking coffee tomorrow morning, yet I can’t even tell you if Google stock will be up or down tomorrow.

NO – you can’t time stocks either, and I’ve got huge money to bet you if you think you can predict stock up and downs even slightly better than chance. 

With stocks when you use a performance record you don’t find good predictive relationships between the past and the future.   Many people think they *do* understand those past to future issues, but in the stock world this does not hold up to scrutiny.  If it did, staggeringly huge returns await anybody with even very modest  level of long term predictive power and a modest initial stake.   How?   

If you could predict the daily up or down movement of any stock  with even a modest level of accuracy you could use options (or buying short and long) to quickly turn a buck.  If the stock was highly volatile and options were available your leverage would turn a few thousand into a few million in a year thanks to leveraging of your success percentage predicting the up or down movement.   If you could predict things with high accuracy – well above chance – you could turn thousands into millions every month.    This does not happen.  

I’m open to a disproof or alternative hypothesis for VC firms.   But don’t tell me about successes and failures  – I want predictions.   There will  *always* be a top tier of winners.   What supports my hypothesis is that those winners change over time and past does not predict future (in Stocks – I’m really not up on VC stats except that the average returns are negative).  

I think VC may have more of a schmoozing human component than stock picking so that may play a role here.   I’ve noticed from the few Venture Capital folks that I know how they tend to be very bright and personable.    Yet even this is somewhat conspicuous given that average VC return is negative, where the average bright personable person is doing well.

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About JoeDuck

Internet Travel Guy, Father of 2, small town Oregon life. BS Botany from UW Madison Wisconsin, MS Social Sciences from Southern Oregon. Top interests outside of my family's well being are: Internet Technology, Online Travel, Globalization, China, Table Tennis, Real Estate, The Singularity.
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2 Responses to Venture Capitalism – luck or science?

  1. Jeff Chavez says:

    I really appreciated this post. I wanted my readers to see this also so I’ve provided a link to it from one of my recent posts:

    http://northstarthinktank.typepad.com/northstar_thinktank/2007/06/the_founders_fu.html

    Keep up the good work!
    Jeff

  2. Pingback: Founders Fund Has the Right Idea - Entrepreneur Blog

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