Risk Wrangling - byline by Jeff Hinck in The Daily Deal
March 21, 2005
Successful early-stage venture capital investing combines elements of vision and risk
management with a hands-on approach. It's not enough for a startup to have a promising idea; it needs
the means and the team to execute. For that to happen, a startup must take advantage of everything the
VC can offer — contacts, experience and money.
While a lot of people still perceive VCs as industry "cowboys," this is a gross misconception.
Once an investment is made, VCs are in the business of risk management. Our goal is to increase a company's potential
while significantly decreasing its risk, much of which is inherent in being a startup. There are four elements of this
risk — execution, market, product and financial. As each of these elements is effectively addressed, overall risk is mitigated,
and an investment becomes stronger and more viable.
Eliminating execution risk involves putting a stellar management team in place — getting top-quality
people who have proven themselves repeatedly. Risk is further reduced when a VC has an extensive network of executives
from which to select talented and proven management.
With respect to market risk, it's important, of course, to do the due diligence to ensure the market is real
and the timing is right for the new product. Additionally, VCs should leverage their own networks of end customers and potential
partners to develop business relationships for the new company that enable faster time to market. Accelerating the company's adoption
rate into the market will increase recognition and further reduce risk.
Displacing an incumbent requires a disruptive technology or business model with an order-of-magnitude improvement
over the current way of doing business. A significant customer such as Verizon Communications Inc. or General Motors Corp. is not going to make
a switch in purchasing from a Lucent Technologies Inc. or an IBM Corp. to a raw startup — unless that startup's technology provides a
long-lasting, sustainable benefit to the bottom line. It is critical that the startup's team understands this market fact.
Reducing product risk is a combination of due diligence, which takes advantage of the technical savvy of in-house
investment professionals, and ensuring a company's personnel have delivered complete products in the past. Products need to be defined
from the customers' point of view, in order to meet actual demand, and kept tightly focused to
increase the chances they will be developed on time and on budget.
A startup's management must avoid being drawn into a never-ending development cycle with prospective customers that say,
"I'd buy it if it just had this additional functionality." This might well be the most deadly phrase a
startup company can hear. Development risk has to be measured closely against how likely the prospect is to becoming a customer.
Part of this knowledge comes from a deep understanding of your potential customer's needs. For example, a telecom carrier that has just
tooled its access infrastructure is unlikely to buy products to create a new access network, but a company that has just deployed
such a network might be interested in a voice-over-Internet-protocol solution to drive services off the new infrastructure.
Finally, there is financial risk, a subject that no doubt many people have learned
a lot about in the past few years. Reducing financial risk is primarily a matter of keeping companies
appropriately focused. In other words, they need to concentrate on one problem and one market area — not
try to solve all the world's problems with their innovation. Having a focused business plan is
essential to replace high cash burn rates with discipline and accountability. It really shouldn't
take a lot of money to get a product to market. And further product development and market expansion
should be paid for from revenue instead of relying on the VC.
The VC brings a lot to the table in terms of managing investment risk.
Structuring and building a solid management team is essential. In early-stage investing,
almost by definition there is rarely a complete team in place. We rely on our own contacts
as well as partnerships with other VCs that bring additional talent to the table.
When we invest in a company in its earliest stage — two guys and a good
idea — there is often more work required then we alone can do. VC syndication
provides another layer of risk mitigation beyond just the financial risk sharing.
At the end of the day, managing the risk in any inherently risky early-stage
company is about active investment management. This means general partners need to take
on fewer projects and practice a hands-on approach. They should be talking to their
companies weekly, even more often if possible. It's never about just showing up
at board meetings and writing checks — it's about constant communication and
really working together through all the issues.
Jeff Hinck is senior managing director at Vesbridge Partners, headquartered in Boston.
Hinck is based at Vesbridge's Minneapolis-St. Paul office.
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Jeff Hinck
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