Cool Kids in the Kingdom of Venture Capital

The kingdom of venture capital was largely built on the grounds that a startup’s founding team, above all else, is the greatest predictor of success.

Success breeds success, so the prophecy goes. First and foremost, most VCs seek startups with founding teams that have been successful (i.e. been acquired or gone IPO) in the past. These founders are the “cool kids,” and everyone wants a seat at their round table. If VCs are king, cool kids are knights.

Behind the throne sits one more player – the bank, so to speak. In venture capital, the bank is called a Limited Partner or “LP”. LPs are where all the money comes from. LPs invest in VCs, who then invest in cool kids. If everything works out, the cool kids are so successful everyone is paid handsomely.

Not only do most VCs believe cool kids hold the key to success, but they’ve spent a lot of energy convincing LPs of the same.    knight sunbathing

Belief in the power of cool kids, it turns out, helps large VC funds maintain their dominance. The bigger a fund, the more it’s able to woo cool kids. Big funds cite cool-kid-access when raising more money from LPs, allowing them to yet again attract more cool kids. Meanwhile smaller funds have a harder time getting cool kids to take their money because they aren’t as deep pocketed or prestigious. The VC industry saw a lot of consolidation over the past decade – more money flowed to fewer VCs.  Bigger funds got bigger while smaller funds fizzled out. The myth of cool kids was a large driver behind this shift.

For example, cool kid worship is why LPs ask VCs questions like “how will you get access to deal-flow?” or “where will your fund’s headquarters be?” At first blush these questions seem irrelevant. Once it’s known there’s a new VC in town with money to spend, it won’t be long before the fund’s Inbox gets clogged with startups wanting to pitch them. Deal-flow is everywhere.

By the same token, in a world with email and cell phones it shouldn’t matter too much whether a VC is headquartered in Silicon Valley or Tuscaloosa. When LPs ask these questions, they’re speaking in code. The real, hidden question is – how will the VC sign up cool kids? Another code word for this is “quality deal-flow,” often said with a wink.

The problem with the cool kid prophecy is – it’s a myth.

Empirical studies have found either no statistically significant difference in the performance of cool kids (vs. ordinary startup founders) or differences that are a lot smaller than any prophesy would have us believe (no more than 12% differences in performance between cool kids and first time entrepreneurs). Despite the hype, the cool kid myth doesn’t account for at least 88% of reality.

Cool kids do have an easier time raising venture capital than others; a definite advantage. However this should be cold comfort to VCs because the mortality rate of venture capital-funded companies is roughly the same as it is for non-venture-capital-funded companies. Easy money has its pro’s, but it seems there are countervailing cons

If statistics aren’t your thing, you don’t need math to question the cool kid equation. In the beginning, Bill Gates wasn’t a cool kid – he was a college drop out with no exit or IPO behind him. The same was true for Steve Jobs. Michael Dell. Zuckerberg. Larry and Sergey. Bezos. Andy Grove. Larry Ellison. Salesforce’s Benioff. Netscape’s Andreessen. Adobe’s John Warnock. Any fund insisting on cool kids would have passed on deals that have come to define the venture capital industry itself.

Don’t get me wrong, lots of great companies are indeed founded by cool kids. Cool kids are good for the world – I tip my hat to them. We’re all glad they exist and they often make amazing contributions to VC portfolios. Yet whether you’re a statistician or a historian, it’s hard to argue they have magic powers or exclusive access to some hidden Champagne room of success.

It would be interesting to see where things fell if we could yank away the faulty cornerstone of cool kid worship from the fortress of venture capital. At a minimum, it would improve the conversation around what’s really predictive (or not) about startup success. VCs who over-rely on cool kids would be forced to improve their thinking. LPs would ask better questions and stop basing critical decisions on flawed assumptions. Perhaps most optimistically, great entrepreneurs who don’t happen to be “cool kids” could get more support without being as quickly dismissed for lacking qualities that don’t really matter.

It’s time the kingdom of venture capital was built on sturdier grounds.

This Post Has 3 Comments

  1. DeAnna Adams

    Very cool indeed!

  2. Kate Steiner

    I pose this question out to the VC sphere–how many times have you invested in a ‘VC Cool Kid’ or team and they have re-delivered to your expectations. Is it really possible or even unrealistic for a cool kid to churn out multiple good business ideas and see them through?

  3. Good article, although there are deeper levels to the analysis. What is “cool” about “cool kids” is that they are serial entrepreneurs, and that experience has significance. Your point is that its significance may be overrated, and that even the best serial entrepreneur is not such before his first funded venture. That is a good and valid point, but there is another reason why an LP’s singular focus on accessing Sand Hill Wunderkinder may be unwise of them. First, the “cool kids” often bid up valuations higher than is in the LP’s best interest. Second, between the opposite poles of serial entrepreneurs and callow wannabees lies a middle ground: sophisticated, well-qualified businessmen that came from backgrounds other than venture-funded enterprises. They are competent but not cool, and they may not reside in Silicon Valley or Cambridge. These are the folks that such LP’s may be missing.

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