Earning the right
Gang Starr ‘Hard to Earn’ (1994)
The funds with the longest track record of investor returns and reputation of being involved with the best companies have earned the right to compete and win in the marketplace. This can be frustrating to funds earlier in their life (i.e. on Fund 1 or 2). This dynamic also leads to explaining part of a virtuous cycle where the best funds historically continue to be the best going forward as success breeds success (generally speaking, though succession planning can be an obstacle here). I have reflected a lot on how investors start to earn this right, as it has also become relevant more recently in some of the deals I have worked on; once in my favour and once against me.
In the one case that worked for me - I was working on a new investment where we spent lots of time with the founders learning about their business and the nuances of how it worked. The business was more complex so we spent the time building a good understanding of this. Overall, we earned the right to win the deal by spending this time and effort which was fed back as a differentiating factor for us by the founders (where others apparently did not). The other factor that helped us earn the right was the relationship with the existing lead investor. We spent time talking them through how our capital could set the business up for success ahead of another round later this year. I had worked specifically with this other lead investor in another deal that went well (despite some rocky moments during COVID) and a good level of trust had been built. This played into the founders’ eventual decision to work with us. In this sense we had earned the right to win this deal by putting in the hard yards with this prior portfolio company during rocky periods. Overall, our terms were comparable to the market/other offers (though one other offer was significantly under-priced) but our time spent to understand the business, get to know the founders and prior relationship with the lead investor earned us the right to win the deal.
In the other case that worked against me, earning the right came more in the form of multi-decade relationships between two firms and brand recognition. This was in another business where I had known the founders for 3-4 years prior to looking at an investment and we were down to the final two best offers/preferred partners. We were creative on our deal versus others. We thought this would be enough to get the deal signed (our terms were comparable), however other forces that had been long at play started to reveal themselves. The lead investor in the company was a brand name US fund and our competitor was primarily of US heritage and had a very strong relationship with this fund (built over many decades). Moreover, the brand recognition in the US of our competitor was very strong given their overall size (billions in assets).
At the final stages we lost the mandate because of this relationship, with the CEO explaining to me that ‘he had to pick his battles with his Board and it was much easier to recommend working with a partner the Board knew and understood well’; he proceeded to say that if for whatever reason our deal didn’t go well that ‘his Board would hold it against him’ for not going with the more familiar US partner. Moreover, the CEO had recently stepped into the role, thus strengthening the ‘picking the battles’ point given he was still early days into building trust with his Board. Overall, our competitor had earned the right to win this deal given a multi-decade relationship with that US fund as well as the US brand recognition they had built (i.e. nobody could argue against working with our competitor). It was a tough pill to swallow but got me reflecting a lot more about this experience.
I also think that earning the right is a key determinant behind venture funds compounding their success over time. Taking Tiger Global in 2020 as an example, from 1980 to 2000 Tiger beat the market return as a long-short hedge fund for 14 years out of 20 and delivered an annual average return of 25%, net of fees to its LPs.[1] When Tiger relaunched after the millennium to do cross-over technology investing the target was 20% IRR and apparently the latest fund is performing at 27% IRR (net of fees). Overall, performance and track-record over at least 20 years (arguably 40 years if you include the long-short funds pre-2000) has built up trust with their investors and has allowed Tiger to earn the right to adopt a new more avant-garde strategy in 2020. From a competitive advantage standpoint, Tiger’s barrier to entry is 20+ years of above market returns and investor trust, which is harder to compete with as a newer fund (of which there are many today) and reduces their true competition to only a few funds who could feasibly launch the same strategy. I won’t opine on the Tiger strategy itself (it seems very macro-driven is all I will say) but it’s thought-provoking regarding competitive strategy.
After the dust had settled on both deals, it got me thinking a lot more about this notion of earning the right, especially regarding new investments I want to do. Have I earned the right to win and what does that mean for a particular context? And if I haven’t, what do I need to do? Are we as a fund doing the work today to allow us to earn the right in the future in terms of investing in the right relationships or building one’s reputation for example? The earning the right question can cut through all the noise of the deal (competition, value-add, relationships, terms to some extent etc) and help an investor think through how to win today and in the next fund which I find helpful.
Longer-term I believe building a venture fund stems from continuing to earn the right and positioning oneself to benefit ever more from this in subsequent funds. Earning the right can come in many forms such as brand, reputation, trust, hustle, speed, specialism, knowledge, experience, scale, contrarianism, and I am increasingly appreciative of this. However, where it starts to breakdown is winning purely on price, as this can fast-track win rates and create a mirage of one’s earning; one that has to come back to bite after enough bets are placed using this strategy. I must think this will impact returns long-term given venture has low barriers to entry and high barriers to exit. This I will leave as a topic for another day.
[1] Mario from the Generalist: https://www.readthegeneralist.com/briefing/tiger-global
