Published in San Diego Union-Tribune, November 16, 2015
Objects in your rear view mirror are not only closer than they appear – they are also more obvious. That is why they call hindsight 20-20.
I see lots of deals, and the question I struggle with – like all investors – is “Which are the good ones?” And so we turn one more time to my favorite institution, which would not give me the time of day 45 years ago – Harvard Business School and professor Pian Shu, who has some thoughts on how to predict if any idea is really a good one.
She starts with Airbnb. The story is that Brian Chesky, co-founder, takes his idea to seven venture capital firms – five throw him out the door after 15 minutes and the other two don’t even return his phone call. After all, why would anyone give the keys to their house to a stranger who might be a serial killer? And today, that goofball idea has a valuation of $10 billion.
With my first startup, it took me three tries with the same VC to get him to invest. We discussed (argued) for six months, but in due course the deal was done. The next day, the day after they invested, they told us to go back out for more money at a valuation that was 50 percent higher – 24 hours later. I thought he was nuts. His answer, “Now that we are investors, the company is worth more.”
But surprisingly, that turns out to be semi-rational. Shu finds in her studies that “by definition, when an investor makes an investment, it changes the probability of success.” Shu goes on to say that when dealing with something truly innovative, it’s very difficult to compare it to anything that came before – because there is nothing before. So in looking back on successes (LinkedIn had 20 rejections before getting funded), the question is – was it the idea itself or was it that the investment turned the tide – in other words does having the “right” investor create a self-fulfilling prophecy? Statistics tell us that the VC brand matters, but more on that another time.
So Shu wanted to find out if you can really predict a good idea. She did a study using 100 mentors who reviewed ideas in a neutral setting, presented in a one-paragraph description in a uniform format. And what happened was that if the mentors coalesced around an idea, it had a 30 percent higher likelihood of success. The mentors proved to be very good pickers, but only in certain areas. They had a high correlation in energy, hardware and medical devices. But when it came to mobile apps and software, they were much less effective.
And the reason appears to be that it is easier to shift in the app/software business – and the infamous “pivot” or shift is really important in building a successful company. Airbnb started out suggesting air mattresses on the floor instead of rooms.
This brings us to the infamous paradigm: Do you bet on the horse or on the jockey? Shu shows us that it depends on which sector. R&D-intensive companies, you bet on the horse, with apps and software, you bet on the jockey.
The next shibboleth to fall is the one that says you need industry expertise to evaluate a deal or an idea. Shu shows that “in the collective,” i.e. the wisdom of crowds model, that industry expertise is relatively meaningless. The idea shines through. The key is being able to see beyond the idea itself – what could be rather than what is. And not knowing the limitations (not having industry expertise) actually frees the investor to expand his thinking.
So you would think that angel groups (where 50 to 100 people assess the idea and the team) would be more effective than not. But that isn’t the case. In fact, the VC model (three to six partners) still statistically wins that battle.
When possible, Shu says, building an MVP (minimum viable product) is the most valuable feature, because then the crowd gets to look at something concrete, not just an idea.
In the final analysis, we have to turn to Yogi Berra who said, “In baseball, you don’t know nothing.” The same seems to hold true for investing.
Rule No. 147
If it were easy, everyone would do it.