Not being stupid is easier than being smart. Is it better than having a good scouting strategy?

August 5, 2013

I just came across an interesting blog post about decision making at a blog called Sabermetric Research.  Phil Birnbaum, makes the case that in a decisions like the MLB draft, it is better to not be stupid than it is to be smart.  By easier, my interpretation is that he means that there is more potential net-benefit in having some insight that helps you avoid picking a player that others might rate highly than it is spotting an overlooked superstar.

The example is that, your MLB team scouts two players prior to the draft and comes to the conclusion that one hot prospect, lets call him A-Lemon, is not as good as his ranking and another player, Hot-Rod, is better than he is ranked.  Many other teams have scouted these players and some teams are probably about as good as your team in judging talent.  When it is your turn to draft a player, do you get more advantage by knowing that A-Lemon) is a dud than by knowing Hot-Rod is a hidden gem?  The author’s logic behind the reason that avoiding the stupid decision (drafting A-Lemon) is better than picking the hidden gem (Hot-Rod) is a little fuzzy but it is tied up in the fact that the competition is doing scouting as well so you won’t be the only one thinking about drafting Hot-Rod – someone else may grab him –  but by doing nothing, you add value by keeping A-Lemon off your team.  There is something like an efficient market hypothesis here except, in this case, you assume that there are always some smart teams that reach the right scouting conclusion and some stupid teams that reach the wrong conclusion.

My opinion is that the real reason that this makes sense is that one fatal flaw is enough to kill an investment into a player (or in our case a company).  Not all flaws are fatal but, find the fatal flaw and you can walk away.

Look, VC investing is not the MLB draft.  We don’t all look at the same deals to build our portfolio and our portfolios don’t play each other.  We succeed or fail pretty much independently of the other VC’s (we are actually more likely to win when other VC’s win).  However, this got me thinking about the value of avoiding stupid decisions (passing on bad deals) versus making smart ones versus deal flow.  Specifically:

1. One way to make smarter decisions is draft deals that others have rated lower for what is clearly the wrong reason. Many Boston or Silicon Valley (BSV) funds rate deals that are outside of BSV lower just because of location.  The trap for the mid-continent VC is that there are both important and unimportant reasons for this.  The important reasons are that local access to talent, strategic partners, mentors, additional capital can be huge advantages. Sometimes a mid-continent company will get crushed by the talent and capital available to a BSV based company.  However, this does not have to always be the case, especially if the VC can bring some of those resources to the table or manage the company is way that is more appropriate to its location.  The unimportant reason for a BSV VC firm to pass on a deal include the simple fact that it is harder work to manage an investment farther away from home perhaps in a city to which he doesn’t already travel.  For the VC’s active in that geography or willing to do the hard work, finding a overlooked investment opportunity is entirely possible and can be the smart, proactive decision.

2. The way to make stupider decisions is to “draft” deals where there are a lot of smart, deep pocketed, brand named VC’s.  That’s why I don’t even look at companies coming out of BSV.  Of course, I don’t assume that the VC’s there are ALL smart, only that enough of them are going to be smart enough to grab up the better deals.  I think that this is supported by the data – we have not seen any mid-continent VC firms succeed with the strategy of leading or joining in syndicates for BSV deals.

For investment decisions, I come out the opposite of the blogger; for venture investments in the mid-continent, it is better to find the underrated startup or, better yet, the undiscovered startup.  In the middle of the country, VCs win by scouting new territory for world class deals not hunting the same deals as the funds in Boston or Silicon Valley.

 

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