The
entire article is being printed in the Nanotechnology Law
& Business Journal but here is a short version of it.
With the advent of nanotechnology and the emergence of venture
capital funds investing in early stage start-up nanotechnology
companies, now is the time to take a closer look at the
venture capital industry and ask some questions on how to
evaluate venture funds who claim they can successfully invest
in nanotechnology and avoid the investment pitfalls of the
dot.com and biotech era.
In the aftermath of the dot.com and biotech bubble bursting,
it becomes very important for investors to be savvier about
how to prevent the considerable investment losses sustained
during those periods of investing in technology. Nanotechnology
is the next big thing in which to invest but investors are
now much more cautious about investing in technology. However
technology still offers excellent opportunities for significant
returns but it may be useful for investors and venture capital
funds to learn from past history.
A number of recent academic studies provide analyses of
the returns to private equity that support this assertion.
First, the findings show that private equity funds, both
venture capital and buyout, generated returns that were
roughly equal to and sometimes less than the returns of
public equity. This contradicts the belief that private
equity has been a source of abnormally high returns compared
to public equity. This should be distressing to most investors
in venture capital funds because this result indicates that
the returns do not justify the risks and management fees.
This should not discourage investors
from investing in private equity as there is still a need
to diversify portfolios. However, this argument to invest
in private equity for that reason would not satisfy the
many small investors, whose 401K and other retirement plan
monies is being managed by LPs that invest in such vehicles
as venture capital. These small investors will demand a
better management of the return for the risk being taken
on investing their retirement monies. An investment manager
that does not garner higher return for higher risk to his/her
investors will likely not stay in that position for long.
A conclusion presented based on this
data was that value can be created through more management
and control by the VC. The studies also conclude that good
venture capital management is a key factor for success.
Funds with good performance was partly attributable to management
limiting the size of their portfolio allowing them to select
only the best possible investments which is a very targeted
approach at choosing a few good deals rather than a carpet
bombing approach. It was found that funds that concentrated
their investments in a particular industry or investment
type produced better returns. In other words, focusing on
a particular sector or sectors of deep expertise can maximize
returns. Of course, this increases your risk, but also the
potential reward, because the portfolio is implementing
a lower diversification strategy and because risk and return
are directly related.
The
conclusions drawn from these independent studies of the
returns to private equity, in particular venture capital,
indicate that it becomes important to pay more attention
to assessing management potential, aside from just searching
for fund managers with previous good track record to ensure
a fund’s success. The chances of a good management team
member of a successful fund leaving to start a new fund
is slim as they often have equity stake in those prior funds
that require their continued participation. However, the
upside is those types of managers are not the only game
in town. The downside and the risk is how to figure out
who is the real deal. However, how these potential abilities
are currently being assessed without demonstrated ability
or track record is limited in scope. There must be greater
efforts to improve their understanding and the assessment
of value of management. It is important to remember that
good information and how a good manager makes appropriate
use of information mitigates risk.
Perhaps this following illustration to describe management
and its value may be helpful to elucidate the purpose and
value of management. “Four workers can make 6 units in an
eight-hour shift without a manager. If I hire you to manage
them and they still make 6 units a day, what is the benefit
to my business of having hired you? On the other hand, if
they now make 8 units per day, you, the manager, have value.”
It is also evident that if they subsequently make 4 units
a day, that there is a problem with the manager. The same
analogy applies to service, or retail, or teaching, or any
other kind of work. Can your group handle more customer
calls with you than without as a manager? Sell higher value
merchandise? Impart knowledge more effectively? That is
the value of management - making a group of individuals
more effective.
Hence, how will a manager of a venture capital fund return
more value than the industry average which is in this case
is also that of the public equity markets?
Another result of the data demonstrated that funds started
by new firms in boon years exhibiting the largest capital
inflows subsequently performed the worst. Such inexperienced
funds resulted in too much money chasing too few good deals
becoming more of a carpet bombing approach. The increase
of capital flowing into venture capital during these flush
times does not go to the best performing funds, but rather
to those inexperienced new funds that are trying to jump
on the bandwagon.
In addition to that, European VC funds lagged in performance
relative to US VC funds. One possibility for that gap was
the assessment that European VC’s were more deal-makers
than they are active monitors and still seem to be lagging
in their ability to select projects and provide value-added
services to their portfolio companies. This is supportive
of the idea that an appropriate VC management could create
similar value add to European deals as is done with U.S.
deals as there is no evidence that the quality of deals
in Europe are any worse than the ones originating from the
U.S. If that being the case, imagine the opportunities available
in Europe with a U.S. style investment and management philosophy
and if there were a venture capital fund that could invest
in European nanotechnology as put forth.
There are many instances of venture capital deals achieving
fantastic returns. This indicates that the private equity
firms have not yet achieved their potential and there is
much room for improvement and that new approaches in venture
capital investing should be considered more seriously. Change
can be a good thing but it will likely be scary for many
who prefer to continue in the current methods because they
have become accustomed to poor performance being the norm.
However, this becomes a problem if even a few investors
take the chance on a different investment approach, perhaps
one that is considered a contrarian approach by some, and
who then get rewarded with returns appropriate for the risks
they took on for something new and untried. At that point,
there will be many fingers pointing at investment managers
as to why they were not able to recognize value when others
did. This is certainly an indication that investors should
change their decision process on how they choose venture
capital funds in which to invest.
If a traditional VC fund is considered successful based
on a 1 in 10 hit rate using a carpet bombing approach to
deal selection; then when a new VC fund comes along offering
a management team with as good deal selection abilities
in terms of investment and technology experts they would
be expected to do at least as well. If in addition, the
new fund also offers credible management capability for
each company invested, this can only increase the probability
of success.
Seraphima Ventures’ business model is based on the assertion
that better management oversight is what tips the scales
in favor of a successful fund. These studies support Seraphima
Ventures’ business model which asserts that management abilities
is a major factor for determining fund performance and success.
If a new venture capital fund with a team that professes
to offer explicitly superior management capability, such
as Seraphima Ventures, potential investors may wish to take
a closer look at what they are offering as it seems they
may well have figured out on their own, without the studies,
how much more that added management value may be worth.
As Seraphima Ventures is focusing on international investments
that investment management philosophy can only improve performance
from European investments as well.
Management is both art and science. It is the art of making
people more effective than they would have been without
you. The science is in how you do that. A manager's most
important and most difficult job is to manage people. You
must lead, motivate, inspire, and encourage them. And sometimes
you will have to hire, fire, discipline or evaluate employees.
Investors are encouraged to increase their understanding
of management and assessing its value since it is not straightforward.
Hence the ability and skill of a VC to understand these
results,
management and market dynamics and to translate it into
an investment strategy for his or her portfolio of companies,
could potentially directly translate into significantly
higher returns than the public equity markets. Investors
are strongly encouraged to do their due diligence on profiling
the capability of the management team members of any fund.
A key takeaway is that these conclusions apply to any industry
where venture capital investment internationally is possible,
not only to nanotechnology. However, it would be best to
implement these strategies now to optimize returns investing
in nanotechnology and to avoid a nanotechnology bubble.
