In Defense of VC Pattern Recognition

For some time now, I’ve enjoyed the back and forth between venture practitioners and entrepreneurs about what constitutes the elements of best practices and cogent thinking in venture decision-making.

Codifying a venture process or methodology has stymied many a well-meaning firm over the years. While there are certain processes and approaches that most firms would recognize as well-reasoned, there still exists wide disagreement among venture investors and the firms they helm about what should drive investment decisions, how much rigor and analysis should play into investment decision-making versus old-fashioned gut instinct and momentum-style approaches and what ideal blend of background, experience and temperament makes for a successful venture capitalist.

The answers aren’t so obvious.

For me, one of the exciting elements of venture also happens to be one of the areas of greatest frustration — to both those in the field and those outside the glass. That frustrating element is the intangible, unstructured and fickle nature of the venture business. The cliché about venture career paths – that to ask ten VCs how best to enter the venture business would elicit ten very different responses — has persisted for the simple reason that it is an accurate depiction of how circumstantial the venture business is. Hollywood agents may have their William Morris Agency mailroom farm league system to help groom aspiring agents-to-be (and weed out the dreamers), but no such finishing school exists for the Sand Hill Road or Route 128 set. Founding and operating a start-up is probably the most obvious and germane way to learn the mechanics of start-up operations and to develop the skills that, later on, will prove invaluable as an advisor to other startups. That said, a succesful entrepreneurial career is no guarantee of subsequent success as a venture investor. Indeed, some of the industry’s most successful venture capitalists never spent a day in a start-up, so go figure.

Correspondingly, just as there exists no feeder school to a venture career, there is no tried-and-true approach to hone good decision-making by both aspiring and practicing venture investors. Into this debate the notion of pattern recognition has been both praised and derided. For some it is a valuable tool — some might say skill —  to help investors separate wheat from chaff. It can frame for an investor likely outcomes from past experiences with similar companies, similar approaches, similar strategies and similar team compositions. Detractors would argue that pattern recognition is not really a skill at all, just an accumulation of trade practices and a prism steeped in groupthink through which venture investors view opportunities freed from truly independent thought and creativity. The problem with pattern recognition as a technique to evaluate an opportunity, the argument would go, is that it is not only a bad substitute for independent thinking, it prematurely nips in the bud potentially promising opportunities by unfairly punishing them for the past failures of companies that came before with similar concepts.

To be fair, that’s not a bad point. Sure, the fact that the last ten companies that pitched me trying to do a GPS-enabled location-based gaming app focused on dog groomers came to nothing doesn’t necessarily mean your company won’t be the next Google. Some start-up team, it could be argued, will finally succeed in that space and that team could just as easily be yours — but I wouldn’t bet on it.

From my perspective, both camps are right to a certain extent. Like any tool, pattern recognition can be too heavily relied upon and can improperly take the place of real thinking and analytical rigor. So, to the extent we are discussing deal evaluation at the earliest stage, I would wager that many investors do prematurely jettison opportunities because their perspective is skewed by knowledge of prior stumbles by earlier market entrants. The more nuanced approach, I would wager, is to more heavily weigh the attractiveness of the space the company is focused upon over the company itself in the initial stages of evaluation. If the investor believes wholeheartedly in the space and is not dissuaded by the fact that so many earlier entrants failed trying to build a business there, then the discussion revolves around whether that investor wants to invest in that space and whether that particular company can succeed. Any forthcoming investment decision, or so goes the hope, will be made based upon the merits of the company and its solution and not upon the number of carcasses on the battlefield from prior attempts to “take that hill.”

To my mind, perhaps the greatest value of pattern recognition is simply a function of robust deal flow. Seeing a LOT of opportunities in a given space is invaluable and absolutely critical to long-term success in a particular area. Sure, there always exists the one-off moonshot opportunity that can land in a venture investor’s lap that becomes the next juggernaut in the space, but the more typical scenario behind most venture success stories is one of a methodical investor meeting every company in the space, learning the idiosyncracies of the ecosystem, and then partnering with the company that that investor believes has the right combination of team, solution, and timing to become a market leader. The pattern recognition that develops in that process, obviously, is a function of seeing so many opportunities in the space, weighing their pros and cons, and getting past the initial frisson and excitement of what every company is doing — and, hence, being dispassionate about the investment selection process itself. I find pattern recognition, as a tool, far less effective as a company matures and the relationship with that company deepens. I have been on great boards and dysfunctional ones; I’ve advised talented CEOs that commanded the respect of everyone in their organizations and I’ve worked with CEOs who couldn’t run a lemonade stand. While I have learned from each of these experiences I find these lessons rarely apply cleanly to subsequent problems. Companies, like people, are unique and applying a rote process or management algorithm for specific eventualities based upon how earlier crises were managed rarely works effectively.