CandidCapital

NESTA, the lottery endowment fund charged with raising entrepreneurial activity in the UK, recently published a report comparing the UK and US VC industries.

NESTA is to be applauded for commissioning Josh Lerner the Harvard Business School professor and guru on international venture capital to analyze the relative performance of the UK and US venture capital industries. Lerner and his team's findings point out some valuable lessons for fund managers, prospective investors or policy makers looking to address the equity gap. Like any good research work the report is based on sound statistical analysis of a significant body of data about fund performance which was, it appears, very hard to come by. Nonetheless its statistical foundation are, it seems to me, its central weakness - an underestimation of the fundamental differences in the relationship between entrepreneurs and investors in the UK when compared to the US.

I went to a presentation of the report's findings given by Josh Lerner at NESTA's offices at the beginning of this month. Two other people were invited to join him on the podium to contribute to the post presentation Q&A session: Laurence Garrett of Highland Capital and Michael Kaplan of Albion Ventures. Josh Lerner's conclusions can be summarised (with a little risk of over-simplification):

• smaller funds work least well, with middle-sized ($85M - $300M under management) performing best;
• more experienced fund managers produce bette returns;
• past performance does predict future performance;
• investors operating in and from concentrated investment hubs perform better than those based outside;
• the earlier the investor invests in a business (albeit with the ability to follow their money) the better the return;
• the more partners a firm has the better the returns it achieves.

However, rather disarmingly and in the manner of Benjamin Graham, Professor Lerner caveats his conclusions with the comments "...differences across funds regarding these factors can only account for about 30-40 per cent of the variation in returns. In other words much of the variability of returns continues to be unexplained."

In my view his principal omission is a failure to identify the different relationship between entrepreneurs and VC investors in the UK compared with those in the US. Laurence Garrett put his finger on the essential US preparedness to sell - oneself, through one's resume, or a product or service when you're at work - in America everyone sells. This characteristic feeds through into a US business culture where the distinction between investor and entrepreneur is hazy at best. Many US venture investors have been entrepreneurs and those that haven't displays traits that suggest that they would be highly effective as entrepreneurs. In consequence there's much more alignment of thinking and analysis between investor and entrepreneur which, combined with a factor which Professor Lerner identifies but doesn't emphasise - sector specialism, leads to better formulated business models where the entrepreneur and the investor have genuine consensus and a shared sense of common purpose. In contrast, in the UK many investors come from a financial services, consultancy, academic or large company background in which they have not honed the acute business antennae of their American peers.

The importance of finding, and then working closely and in harmony with exceptional entrepreneurs was also picked out by Laurence Garrett who commented that the entrepreneur who can continually adapt his or her business model to evolving market reality "from garage to IPO" is a rarity that's worth hunting long and hard for.

2 June 2011