Terry Jones

I’m very curious about the correlation of perceived early stage (seed, series A) startup risk and the eventual reward. That is, if you plotted a set of well-informed potential investors’ perception of a collection of startup companies’ risk against the eventual performance of those companies, what would the plot look like?

Would it be low-risk low-reward and high-risk high-reward? Would it be all over the place?

In an earlier post, the blind leading the blind?, I wrote about it being extremely hard (or impossible) to assess value. I’m sure that’s true in one-off cases, and that it’s true for entrepreneurs who by definition have relatively little practical experience with startups (sure, they may have read a lot, we’ve all read a lot – I mean in actually doing them).

But is the same true for investors? It’s certain that the bulk of investors get their results all over the map – some things that look safe end up worthless, some things that look like big risks end up paying off big time, and everything in between. If it were otherwise, the investment game wouldn’t be what it is – it would be much safer and more predictable.

One question I have relates to the relationship between extreme risk and extreme reward that I wrote about earlier. I.e., if risk and reward always go together, then you can’t reap a huge reward without taking huge risks.

But perception of risk is subjective. A run-of-the-mill VC might see something as hugely risky, not make the bet and so miss a huge payoff. But an exceptional VC, presented with the same investment opportunity, might see accurately that it in fact was destined to be big (i.e., consider it relatively low risk) and make the home-run investment. Do such VCs exist? If so, and we knew who they were, we’d be clamoring to pitch to them, to invest alongside them, to study there methods. Does Sequoia fall into this category? Or are they just lucky, or maybe they simply have access to better quality deals because of their track record, etc.

That’s why I’d love to see a plot of perceived risk against reward. I think in general my feelings about entrepreneurs would also hold with investors – that the really rewarding things are strongly correlated with the really risky. An investor with that sort of profile doesn’t really know any more than the rest of us. But might there exist a class of investor who can look at things that are going to be hugely rewarding and not think that they’re also high risk?

Here’s another way to put it: Maybe risk and reward always go hand in hand, are always proportional, that to get high rewards you must take high risk. If so, a VC firm cannot possibly be sitting on the next Google (or whatever) unless they have one or more companies in their portfolio that scare the shit out of them. Or, might it be the case that while risk and reward appear to go hand in hand to many, there are a few superb investors who perceive risk differently and looking at their plots we’d see that they made tons of money by taking what looked to them like low-risk bets? Or maybe the entire premise is wrong and risk and reward actually aren’t well correlated, let alone perceived risk and reward.

This is a bit of a rambling post, I know. But it’s what I’m thinking of these days. I would at least know how to make the scatter plot I’m imagining, and it’s fun to speculate on its shape – both across multiple VCs and for them individually.

You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.