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June 16, 2006
A-Teams and B-Teams in Venture Deals
One of the predictable discussions leading up to any venture financing is whether the startup's team is an "A" team or a "B" team. Have they done it before? Is the CEO polished and professional? Does the CTO have the right laundry list of former employers? It is a tiresome discussion, but venture guys obsess on it as a way of managing deal risk: Bet on the jockey, as it were.But is the logic right? Not to say teams don't matter, let alone getting into the neverending teams vs. technology debate in venture capital, but a) is there as much of a performance tradeoff between "A" and "B" teams as investors think, and b) can venture investors really tell the difference, a priori, as neatly as they think they can?
I recently saw some data comparing the performance difference between a priori "A" CEOs and "B" (and even "C") CEOs in one venture firm's portfolio, and the "B"/"C" CEOs kicked the "A" CEOs' asses. Was it because the "B"s were better, or was it because the venture investors weren't as good at spotting "A" CEOs as they thought they were? Good questions both, but the result was fascinating: Weaker teams outperformed stronger ones.
There are plenty of reasons why this might be the case, including that it is typically more expensive (along some dimensions) to run an "A" team. They cost more money upfront, they require more salary, they require more equity, and they are often more headstrong and difficult to advise as a board member. There is a lot of to be said for having an inexpensive and influence-able team running your venture.
You can see this sort of thing in microcosm in Hollywood, where the ardor for "A" teams finally seems to be subsiding somewhat. Producers are finally conceding that inexpensively produced "B" projects make more money, at lower cost, and with less risk, than the latest and greatest tentpole flick. Food for venture investing thought.
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Oops, way too many typos today, sorry. Time for coffee:-)
There just isn't much glitz in backing a Roger Corman production!
To synthesize a couple of points in your post, perhaps VCs overestimate the (extremely fuzzy) *executive performance* differential between A- and B- list. Hence, they screen B-list executive deals so heavily that only the very best deals make it through. The *investment performance* of the B- list deals may then outperform the *investment performance* of the A- list deals, even while the *executive performance* of the B-list executives may be less than that of the A-list executives.
Interesting data. Can you please share it with us?
World Cup soccer comes to mind. Brasil and England fall short of (high) expectations while Ecuador strides powerfully into the second round.
Do you think it could be that startups that get funded despite having a B team need to have more going for them to justify funding? Reputation has bankrolled a lot of bad ideas.
i'm all for the 'avis strategy.' nothing motivates people like having a competitor in your sights.
I truly think it's not as complicated as you're making it.
Basically an "A" team are, by definition, going to play the game better than a "B" team.
VCs saying they want to invest in an "A" team is like gamblers saying they want to play poker with "A" players. Better for the ego than for the wallet.
Paul: "I recently saw some data comparing the performance difference between a priori "A" CEOs and "B" (and even "C") CEOs in one venture firm's portfolio"
This data really isn't useful without looking at the other side: how did the average "A" team do in terms of personal compensation compared to the average "B" or "C" team. As you yourself say: "they cost more money upfront, they require more salary, they require more equity". Which is to say, they hold a better hand, and they play their cards better.
Michael -- You're missing one of the main points. It isn't as easy as venture orthodoxy would have it to separate "A" teams from "B" teams. Different circumstances can make a previously effective CEO/team less effective, as can the passage of time.
Venture investors act as if such is not the case, and that, in part, explains why "A" teams (based on the historical record) are so often outperformed by "B" teams.
I'm not missing the point. I'm pointing out that your point isn't a point until you establish that so-called "a priori A teams" underperform "B teams" *in terms of their OWN pockets*, not the pockets of the VC investors.
(Unless that is, that you want to argue that "A" players are primarily motivated to make their investors rich at their own expense, and simply fail at this for whatever reason.)
Okay, then you're making a different point. I'm interested in the fallibility of venture investors in a priori identification of "A" and "B" teams, and how teams annointed as A/B go on to do from a venture investor's perspective.
Answering the question of how teams of varying skills, in some Platonic and absolute sense, do for their own pockets, is, at least to me, a different and less interesting question.
Paul: "I'm interested in the fallibility of venture investors in a priori identification of "A" and "B" teams"
It's actually the same point: venture capitalists are, for the most part, not as clever as they think they are.
One consequence of this is that they overestimate their own ability to judge who they are dealing with (your point).
Another consequence of this is that they underestimate who they are dealing with (my point).
In order to properly apportion the cause of the counter-intuitive performance results between these two points, you need to know not only how the VCs did on the deals in question, but also how the teams did on the deals in question.
Now, it may be the case that the "A teams" come out worse, personally, than the "B and C teams", in which case your point would be the prevailing causal factor.
That is to say, the VCs can't really tell the difference between A, B, and C teams.
However, if the "A teams" come out better, personally, than the "B and C teams", then your point is probably not the prevailing causal factor for the counter-intuitive performance results.
That is to say, the VCs may be able to tell the difference between A, B and C teams, but the A teams leave less on the table for the VCs because they are smarter and more experienced.
Paul,
Great post.
I'm exposed to many cases on regular basis where the CEO has managed to bootstrap his/her company into a $30M-$50M business (pre-money). In most cases, such CEOs are considered B-Team CEOs if they have not had a successful VC funded exit or if they had not had the right employment history.
Yet, I see (on regular basis too) VCs investing in some extremely dumb ventures that are guaranteed to fail just because they deem the team to be an A-Team.
Marc
James Surowiecki had a good piece in the New Yorker on the phenomenom in the TV business a couple years ago (http://www.newyorker.com/talk/content/?020304ta_talk_surowiecki). The closing lines of that piece ring true for the VC world as well:
"'Look, everybody is scared all the time,' [TV Producer Dick] Wolf said. 'So you think signing big names is a hedge, and in some ways it is.' The problem, as William Goldman has observed, is that it's a hedge not against losing money but against looking foolish while doing so."
That's a great quote, JD. I think Dick Wolf hits the nail on the head, and I also think this relates back to the whole, "Too many VCs really want to be in Private Equity" line of reasoning for the failure of many overly conservative-minded funds.
Interesting thought, but you don't clarify your terms ("A" vs. "B"), and you don't cite your source ("I recently saw some data"). Kind of hard to draw any conclusions based on this.
Alex -- Okay, but this is a blog, not an academic journal. The situation was as described: Internal data from a well-known venture firm; and the slippery and subjective definition of "A" and "B teams is part of the problem, certainly not something I'm going to define away.
Ah, see? England and Brazil are out. However, you might be able to set fault on the management, er, coaches.
I suppose a lot depends on the defintion of the "A" team. "A" as in proven so in the past, or "A" as in talented, driven, smart? Obviously judging the letter is quite subjective, and without the track record may be considered "B"... when indeed those are some of the character traits you'd be looking for.
"A"'s with a proven track record (and financial sucess) are sometimes less driven.. and of course the worst-case scenario is the "4-star general": the A-player proved himself in the corporate world, had significant positions in a relevant field ..etc.. except he fails without the supporting infrastructure and huge staff in a startup.