Can Venture Capital be Lean?
The Lean Startup creed is now deeply intertwined in every conversation about building innovative and scalable businesses. Lean is not the only way to build innovation, but the concept has somehow become an obligatory topic when those businesses are built and refined.
It’s been years since I tried to tilt this discussion towards Venture Capital – mainly, how we should (if ever) consider a lean approach to the VC business. When I first compiled my initial thoughts and drafted this post back in 2012, I sent it to 5 VC friends I respect. One replied with “this is a wasp nest you don’t mess with”, and the other sent some feedback: “The overall ideas are nice and you should try this – but don’t count on me…” Thanks for boosting the morale, buddy.
After a long pause with this whole thing dwelling in my head, here’s that draft my VC friends couldn’t care less about.
The VC business
This is a factual and brief description of how most VC funds work:
- The General Partners spend a couple of years raising the fund
- The Limited Partners’ capital is partially used to pay for the fund team’s salaries, costs, and expenses
- The fund team captures, analyzes, and processes dealflow to pick specific startups as potential investments
- Analysts are assigned to dig deeper into a couple of startups from the dealflow pipe
- A negotiation process takes place and the fund managers decide whether to invest or not
- The money is deployed and the startup is evaluated over its investment period
- The startup founders use the money as they see fit, under some control of the fund and/or formal Board
- The startup will either die, stabilize or grow. Success is whenever the fund sells its shares, yield returns to the LPs and takes a cut of the profit.
If Lean is about reducing waste, that means solving inefficiencies, constantly measuring performance, reassessing the operation and optimizing internal processes. So here’s an experiment for you. Pick any VC you’re close with, and analyze how they perform those 8 macro steps. You will find waste in most of them, and here are some examples:
- Depending on how GPs approach LPs (and who they approach) they may take much longer than planned to raise the fund. They often need to close the fund without reaching their intended watermark.
- Salaries, costs, and expenses are poorly budgeted – either too low or high. They may hire young, cheap and inexperienced people, or experienced but expensive analysts.
- They have no concrete way of measuring performance when managing the dealflow. VC is an art, they say.
- Analysts may miss incredibly good opportunities, or invest too much time on false positives.
- Inexperienced VCs take waaaay longer to negotiate termsheets, and sometimes forget investing is a fair game.
- There is no pragmatic approach on how to quantify startup maturity or measure its evolution.
- Frequently, the money is deployed in large chunks on immature startups – and VCs mostly pay for entrepreneurs to learn and make mistakes.
- VCs are used to burning money. They know only a couple investments will really work – the others will die or zombiefy, and that’s just the VC business.
So here I am, stating my case: the average VC fund is a pile of waste. And though VCs criticize entrepreneurs wasting time and money, the VC fund itself doesn’t minimize waste on its own operation.
On both cases, it’s other people’s money to spend. But if you wear angel investor shoes (I do), you start thinking about how you’d use that money in a smarter way (and the most fiduciary way of all): as if it was your own.
The Lean approach
I’ll spare you a long explanation on the Lean principles, because Wikipedia is there for your amusement. In respect to Lean and venture capital, there’s a couple of examples worth mentioning.
What we’re doing is a quantitative experiment at scale to do quick cycle-time product development, and then increase capital for things that are working. (…) We can do lots of fast experiments that are cheap, they may fail at high rates, but we’ll be able to determine success quickly. (…) This is sort of putting Internet entrepreneurship into the Henry Ford era: assembly-line startup kind of efficiency. We’re able to do this at a very, very large scale.
Even so, I believe there’s more to that than “lots of little bets, doubling-down on a few” and the product / market / revenue investment thesis. In fact, Dave does run a noisy itinerant party and did create a good heuristic to reducing waste – but minimizing waste on venture capital is an important discussion.
AngelList, founded by Naval Ravikant, is my second example. Naval and his team implemented and distributed a beautiful business model for venture capital. AngelList can be seen as a much leaner VC than 500startups: they operate venture capital as a platform, so that both small and big VCs can rely on them to enjoy a less bumpy ride, worry less about handling picking a portfolio and more about important things such as the differentiation of their investment strategies.
AngelList’s tools and processes dramatically boost the dynamics of the VC market, easing the money flow for entrepreneurs and investors of various sizes. That’s an incredible achievement, and the world is a better place because of them… But not all investors can or will use the software approach, and may still want to do something about the VC waste.
Bringing those two examples to light (and believe me or not, there are not many other real-world examples) is my way of convincing you that there’s more to Lean VC than has been historically discussed.
My proposition is that Lean Venture Capital should be defined as a systematic and pragmatic approach to minimize waste on the key processes that really impact the investor life. Here’s a quick list:
- Getting dealflow
- Processing dealflow
- Negotiating and closing deals
- Assessing the investment portfolio
- Making liquidity-related decisions
If those processes are addressed in careful detail, one can model a different way of operating an investment portfolio – be it a fund, corporate, or personal one – and maintain one’s personality without having to mimic 500startups or AngelList. I’m not talking incremental changes such as cutting costs or reducing management fees (a lot of funds already do that to become less fat, but not lean). I mean sistematically trying to scale up a venture capital operation.
If you like what you read, don’t miss the next post: how to better treat dealflow and give proper feedback to entrepreneurs.