Stories of the Sleepless

Jason’s heart skipped a beat when an 8-9-10 flop hit the poker table. His cards lay face down in front of him, but he was sure he held a 7 and a Jack which gave him a straight. Everyone folded to his modest raise except for Phil, who paused for a minute before calling the raise. Jason celebrated in his head as he began to smell a big win coming his way. Careful not to scare Phil off the hand, Jason made the next raise only moderately larger. Phil twisted in his seat and arched his back to crack it. Phil took his time on this round. He looked at his finger where a wedding band had previously existed twice before and then over to the young gentleman in the hoodie. Again, Phil called. On the last card, Jason pushed all in and Phil called immediately. Phil won the hand with Jack/Queen. A better straight. Jason sat stunned for a moment and watched the chips move to Phil’s stack.

“I can’t believe it.”  Jason said almost to himself.

“Always believe in the potential for the unbelievable.” Phil responded.

Entrepreneurs tell VCs that “failure is not an option”. Venture capitalists smile and nod but understand that losses are inevitable and simply part of the business. The standard line is that we live in a 2-6-2 world. This is the metric that espouses that out of 10 investees, 2 will burn, 6 will forever hobble along and 2 will provide sufficient wins for the entire portfolio to make economic sense. I think it’s now safe to say that the real metric is something much more extreme than 2-6-2 and that this metric is much too optimistic. The funny thing is that the failures are rarely discussed. We highlight the wins. Drinks are quaffed, someone buys a salmon dinner and there’s a blue ribbon for deal of the year.

“So how’d they do it?” Buzzes the community.

“Well they had a great team with a fantastic product for a big market where every customer bought.” Beams the VC.

“Wow. Great story.” And we skip back to the shrimp table and wish we’d gotten in on that one.

Since we now know that successes are the vast minority, we should be spending a higher proportion of analysis on the ones that didn’t work out. What was learned by the entrepreneur? What was learned by the investor? Want to find an entrepreneur that is highly motivated? Find one who bears the scars of doing it wrong.  It isn’t necessary to reduce the number of failures however it is necessary to stop funding those who “just might turn this thing around and get there”. Statistically, you’re betting on a bad straight. Repeatedly, we are continuing to fund until it’s too late. We do the same thing as the entrepreneur who claims he will remain on as CEO until it’s time. What he doesn’t know that he means is that he’ll stay on as CEO until it’s too late and so will the investors. Killing the deal quick reduces the losses, leaves more money for the ones with traction and allows the entrepreneur to get out and go again on a new deal.

We are currently in the midst of a blizzard of startup conferences. T’is the season. Successes are great and we should still celebrate them, but there’s a lot more to be learned from the scrap heap for both the investors and for the entrepreneurs if we would just be willing to discuss the tale without playing a blame game. We don’t talk about it because it’s embarrassing, but why? If we all agree that outlier successes are much less than 10%, we should be free to discuss the non-winners which involves the majority of our business. If we do, we will all get better. Instead we discuss the outliers. Finding out that an investment is a failure shouldn’t be disappointing when we know that most are not the big win. The good news is that we’ve quickly identified the failure and are now saving follow-on capital for the successes. And finding the failures can be beautiful. The best failures are the ones where we all acknowledge them quickly and will limit our downside by not investing more. In an industry where most deals are not financially successful, that’s just a beautiful, necessary failure and a win.