UK: An Investment Team's True X-Factor: Can You Spot Talent That ‘Gets' Talent?

Last Updated: 25 October 2018
Article by Simon Radford

As the leading reviewers of venture capital funds, one of the topics we delve into in our due diligence is how investment teams assess the management of potential investee companies. Some, of course, have a more sophisticated and thoughtful approach than others. What is remarked upon and explored less often, however, is how investment teams evaluate how management teams assess talent. By examining the principles that underpin how the management team hopes to build their core personnel, it is possible to take a view on the kinds of individuals the firm will attract and the culture they will build, together.

When early-stage businesses take on venture capital, the ambition is clear: rapid growth. In order to deliver growth and to support increased activity, most firms will need to hire more staff. However, hiring the right person is hard: armed only with a resume, a cover letter, and an hour or two in someone's company, it can be easy to hire only those people with whom one feels most naturally comfortable, further perpetuating the problem of interviewers hiring people who resemble themselves, impacting diversity and encouraging groupthink. Do interviewers have a clear set of guidelines to follow, to help them make better decisions when trying to hire the right people for the business? Netflix's famous "culture deck" was created as a response to being more open and honest in terms of the type of ethos that the firm was trying to create ("more of a sports team than a family") and to look for those personalities that would add to this effort, while Google focus simply on two traits that they deem the best predictors of success within their firm: persistence and curiosity.

In the same way, evaluating management is one of the key skills of any venture capital investor: will they be able to pivot when they need to? Will they be careful custodians of investors' money, improvise where they can and only spend resources when they really must? Do the different team members complement each other? Where one founder is more of a product person, the other might have more business acumen; where one founder is more of an introvert, the other might usefully be more extroverted, happy to network widely and more comfortable selling. Indeed, the founder of Dropbox was told to find a co-founder before the company could be admitted to Y Combinator, Silicon Valley's premiere start-up incubator programme. While some investors go more on "feel" for a particular founding team, or assess mainly their background and technical skills, other venture capitalists publicly list the attributes that they look for in a founding team.

Founders can often be charismatic micromanagers, so precious about their idea that they stifle innovation, or hire more people who again resemble themselves. As Facebook COO Sheryl Sandberg said in her MIT Commencement Speech, "We cannot build technology for equality and democracy unless we have and we harness diversity in its creation," reflecting on her experience of having to press for both cognitive diversity as well as representational diversity in the teams she has led. Reid Hoffman, the CEO of LinkedIn, acknowledged that he did not necessarily at times have the appropriate skillset for the expansion of the company, with the potential to hamper growth. Reid showed real bravery by stepping down from his post on two occasions when he felt that as a founder his abilities were not beneficial to the organisation. As a Partner at Greylock, a leading US venture capital firm, he looks to see that a start-up's CEO will be able to take the tough decisions to reshape the team as the firm grows and demand more experience managing larger businesses as that start-up grows to scale.

As well as evaluating whether founding teams have what it takes to discern the best talent to join them in their bid for growth, investment teams also have to make sure that Founders will appropriately reward those whom they hire. Employees need to be content to have sacrificed other opportunities and take the large risk of joining a fledgling venture facing a large challenge to scale. Here a management team needs to create a culture that rewards innovation, gives everyone a voice, as well as giving employees a real financial stake in the future success of the company.

In a major recent report on rebooting Britain's low productivity economy, the IPPR thinktank argued for much greater worker representation on company boards to boost the nation's productive output. The economist and financial commentator Chris Dillow pointed out that "increased power for workers directly raises their well-being. People don't just care about what they get, but how they get it. Processes in which they have a say are better than ones in which they don't". Finally, for cash-strapped start-ups with a need to carefully manage working capital, paying employees in equity/hope might well allow for a better chance of scaling than founders owning a higher percentage of a company weighed down by a much larger, market-price wage bill.

Just as investment teams need to evaluate the management of the companies that they perform due diligence on, they also need to look at the 'second derivative': assessing how management teams assess talent. Here at MJ Hudson Allenbridge that gives us the challenge of going one level deeper still: assessing how investment teams evaluate management on their approach to attracting and retaining top talent. As any seed investor knows, products will change when they meet the realities of the market and management needs to be prepared to pivot and innovate on the fly. To do that they need a team willing to bend but not break when times get tough. It's only by drilling down into this core truth that investment teams can properly assess which management teams have the ability to lead their team on a long journey to commercial success.

Finally, venture investing is a competitive sport: if someone has an advantage, it should be expected that a rival will likely try and copy it. An old story has it that, after spending months and millions on trying to beat McDonalds to prime locations and failing, the management at Burger King did the next best thing: wherever they saw a McDonalds opening, they opened a Burger King across the street. So too dealflow from a particular city or source that seems to yield great returns to one manager is likely to see other managers try and encroach on their turf and get a piece of the action. Advantages rarely last.

So how should researchers like those of us at MJ Hudson evaluate claims to "regional footprints", the opening of new offices, or geographically diverse angel investor networks? The only way is to look behind the claims and evaluate the quantity and quality of dealflow itself and look for real barriers to entry for other managers accessing the same. The hunt for the British Apple or Uber is unceasing, and managers will and should always be looking to find pockets of value unavailable to their peers, but the proof that claims hold up should only ever be evaluated in cold numbers.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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