In 2012, Kaufman Foundation's "WE HAVE MET THE ENEMY... AND HE IS US" reported:
Venture capital (VC) has delivered poor returns for more than a decade. Speculation among industry insiders is that the VC model is broken, despite occasional high-profile successes in recent years.
Conversation about less-than-expected performance with venture capital and private equity funds continues to grow. Consider the following recent conversations:
A recent Forbes article outlines:
It's gotten a lot tougher to succeed in private equity in the past 10 years. The Cambridge Associates U.S Private Equity Index had an average annual return of 8.22% for the five years ended 30 June. For the 10 years, the average was 14.12%.
Private equity groups have to change from financial engineering to building value.
A recent McKinsey report highlights:
The new priority for success is differentiated capabilities. Limited partners (those who invest in the funds raised and managed by general partners) expect funds that exploit a general partner's distinctive strengths will do well. Institutional investors will need to get better at identifying and assessing these skills, and private-equity firms will need to look inward to better understand and capitalize on the factors that truly drive their performance.
And Harvard Business School senior lecturer Shikhar Ghosh's research indicates that as many as 75 percent of venture-backed companies never return cash to investors, with 30 to 40 percent of those liquidating assets where investors lose all of their money. His findings are based on research of more than 2,000 venture-backed companies that raised at least $1 million from 2004 to 2010.
Unfortunately, I'm no stranger to those statistics. I know painfully well from my own failures how venture-backed companies fail.
I use the term "odds of success" to draw upon the analogy that more times than not, the strategy employed by VC/PE funds made closely resembles that of gambling. A play on probability: the theory that in a numbers game, some will win and some will lose, is not an acceptable approach.
Financial Analysis vs. Operational Capabilities
While the venture capital industry has changed a great deal since the days of Georges Doriot, founder of the American Research and Development Corporation, portfolio management styles have not. The industry still places the greatest emphasis on financial analysis vs. operational capabilities.
While the financial details are crucial, they do not contain enough forward-looking information to understand, track and govern the venture performance of today's ever-changing market brought on by operational challenges and swings.
In today's increasingly unpredictable business environment, there are a number of operating difficulties that must be addressed. Some of the most critical are:
- Accurately evaluating growth potential, while balancing new innovation against operational execution
- Developing sustainable processes to reach or exceed revenue growth goals, cut costs to preserve recurring dividends, and protect top- and bottom-lines for portfolio companies
- Implementing strategies for building sustainable brand recognition, in concert with building brilliant management teams
- Demonstrating progressive, provable, repeatable results that will sustain the firm today and tomorrow
- Creating visibility among boards and investors of ongoing operations that provides perspectives needed to understand how to guide portfolio companies.
Saying, "But this is how we've always done business" isn't sufficient for today's challenges. That's the old, seat-of-the-pants model. Establishing specific objectives and applying reliable performance indicators are keys to a manageable process.
To that end, great benefit could be realized by portfolio managers using transparent operating blueprints that connect the dots between financial reporting and actual business operations in order to accurately represent such information across their holding companies.
An operating blueprint allows principals and a management team to work together based on converged intelligence of market opportunities, execution capabilities and business model differentiations. Properly implemented, operating blueprints allow fund managers to:
- Maximize ROI at an earlier stage in the fund lifecycle of each portfolio company, and collectively across the entire fund.
- Focus on long-term vs. short-term goals to ensure that the life expectancy of a portfolio company allows it to deliver more than just a one-time target.
- Increase transparency between a portfolio company and the venture fund.
- Bring large-cap business process improvements to the small-cap mindset of many venture portfolio companies.
- Prioritize and guide improved performance, value, and sustainable growth.
The Road to Success
Clearly, new ideas, strategies and management tools are essential as the capital markets continue to evolve. In today's volatile market, the success for a new venture is often driven by its ability to recognize significant challenges and immediately identify the strategic imperatives necessary to address, survive, surpass and thrive despite them.
To manage most business operations, it is need to cultivate a culture of risk management that is vigilant in its pursuit and disciplined in its execution. Strategic risk refers to the risks facing the firm due to poorly envisioned or executed business strategies. Among others, these risks include;
- Business model risk -- the robustness of the business model and how well it is being executed;
- Competitive risk -- the ability to sustain itself against competitive action and retaliation;
- Integration risk -- the risks of inadequate integration between business strategies, execution processes, and supporting process/technology infrastructures;
- Misalignment risk -- inadequate alignment between spending and business priorities;
- Governance models risk -- inadequate participation and involvement of executives on key decisions and lack of understanding of inter-dependencies.
Managing systemic risk requires establishing mature risk cultures that are characterized by a set of essential management processes and practices.
By removing the guesswork and emotion, this fact-based and methodical approach allows entrepreneurs/management and investors to come together and collectively work toward the same goal of improved business execution, which equals improved shareholder value -- and that's something everyone can agree on.
Serial entrepreneur and author Faisal Hoque is the founder of SHADOKA and other companies. Shadoka's portfolio of companies (R&D driven products, services, and thought leadership) accelerates individual and organizational sustainable growth. Author of several books, his newest book is "Everything Connects -- How to Transform and Lead in the Age of Creativity, Innovation and Sustainability" (McGraw Hill, Spring 2014).