How can you possibly hold to the virtues of a sage like Buffet, whilst simultaneously expound on the benefits of technology, applauding the pace of innovation? Can you be both a value and a growth investor? What does venture capital provide that traditional investing does not?
Quarrelsome questions abound.
Fundamental forecasting
The difference between these two investing disciplines is the consideration of likely outcome – the view of future value. On one hand are status quo investment principles, and on the other, the bevy of disruptive investing theses.
Warren Buffet is of course the paragon of the status quo. He exemplifies this class of investor. There is nobody else that even comes close. He is unparalleled in his view of the world: that what is most likely tomorrow is what has happened today. His applies his framework as a delicate balancing of asset prices and intrinsic, fair value – he wants to buy bargains and hold great brands that continue to accrue value.
Investment ideas in this genre are iterative rather than innovative. His portfolio is built around stable companies with good cash generation, moats, margins, and proven teams. He likes high probability with low volatility. He centres his universe of possible investments within his circle of comfort and competence. He’s absolutely brilliant, and he runs away from change.
Venture investing in comparison is a fast-moving, paradigm-shifting form of optimism which requires investors to ignore the cacophony of critical consensus and suspend the reality of status quo, to glance upward and forward and to attempt the impossible: predict the future.
These forecasted visions are low in probability, high in potential impact and rely on growth of popular awareness and use of the new thing. Disruption is not avoided by these investors, but considered through the framework of a mosaic: each business idea stacked against what the venture investor believes the picture to be, determining whether the next tile fits.
Venture investors don’t have to be as relatively brilliant as Buffet. Nobody is an expert on the future.
Competing but not comparable
In order to apply either framework, the question is Which type of investment are you analysing? Company with aspirations of building the future? Venture principles apply. Currently capturing value? Status quo investing.
Although each category theoretically competes for wallet-share of an investor, the list of similarities between the two classes of investment is not long. Both categories of investment require disciplined capital allocation. Both provide real returns over time. Both sets of investors seek out excellent leadership teams. But their respective thesis on value and how to capture it could hardly be further apart.
Companies that are already part of the world’s status quo are likely to continue operating similarly in future. Investors consider relatively stable forecastability a virtue, and therefore find reasons to use historic performance as an indicator for a company’s future. This holds true in the medium-term, which means that with enough historic data, accurate pictures of established companies can be formed. In turn these can be assessed and valued, compared to the company’s stock price, and determined as whether worth investing into or not.
Early-stage companies have no such data to rely on. And certainly they are not anticipating stable growth trajectories. Due diligence for venture capital investment revolves on the mosaic future the VC firm has built to believe in: how closely aligned is the company to the future the VC is helping create? The question of whether to invest or not is forward-looking, acknowledging that a great number of things must go right for any value to be accrued at all. And for taking such a bet, the reward to the investor in this category of investment must be considerably higher.
Support is different
Post-investment management work, or ‘portfolio support’ is also expressed differently in each category of investment. For investment managers taking significant stakes in large companies, governance is key: it ensures that the business keeps winning at what it’s good at.
In a start-up or early-stage company, business development (in both strategy and sales) is fundamentally more necessary. This is the reason that investors who are also industry experts are typically sought after by start-up founders. It is also the reason that institutional capital – expecting specific reporting and governance frameworks to be in place, struggle to invest in young ventures.
These two post-investment skillsets are necessarily different. Which means that a self-aware investor is able to determine whether there is alignment and strategic fit for any particular investment opportunity, far before the deal is consummated or due diligence even commences. Ideally, she should only consider investments that are a strategic fit for her skillset!
Applying the theory
How is this applied in practice? Mandates. Funds are raised to invest into specific mandates, which are guardrails against chasing investments outside of a fund manager or investor’s strategic fit.
When investors provide capital into a fund, they ought to thoroughly investigate the team managing the fund, forming their own view of whether the fund’s intended investment universe is a match to the team’s expertise and experience. This piece of work should be regularly done by every investor class, and with much vim and vigour – although the countless failed funds show evidence to the contrary.
An investment team in positioning to the diligent investor must at all times be able to articulate what type of investments they pursue, how they forecast value, what metrics indicate performance per investment, what work has been done on probabilistic outcomes, and how they determine their own value-add in order to drive and capture value for each investment.
Drivers include things like assistance with product, team, strategy, asset, geography and project expansion, brand extensions, marketing positioning, processing power. And the very best investors are excellent at just one or two of these.
Lack of clarity from an investor indicates a poor understanding or underlying thesis of that capital allocator. This is resolved by a clear articulation of the type of investing that investor is doing. Beware investors touting disruption and innovation as ultimate objectives. Innovation does not create investor value – in many cases it loses it! You need to be invest in companies pursuing durable competitive advantage – the moats previously described – and then the investor’s job (in both categories of investment) becomes more simple: find a way to help the company capture that value.
That’s, ultimately, what venture and status quo investing should all be about.
October 2023