So Techcrunch has this guest post on serial entrepreneurship. Very interesting reading, for both entrepreneurs and investors. I think this quote sums up the article pretty good:
While second-timers’ experience may lower the likelihood of failure, from 82% to 70% according to one study, no one has noticed that it also seems to limit the magnitude of success. Every Silicon Valley colossus — Amazon, Apple, Dell, Ebay, Google, Microsoft, Oracle and Yahoo! — was started by a first-timer 30 or under. Facebook was founded by teenagers.
The implicit meaning of this quote is, of course, that second-timers are more likely to succeed, but first-timers are more likely to make it big. The reason given in the post is somewhere along the lines of “first-timers are more hungry, experimental, naive and daring” and “second-timers are more confident (=less experimentation) and less motivated”.
In theory, it’s a simple risk and reward-equation, and it’s the job of VCs to source interesting projects and balance these two things against one another. But most VCs I’ve met aren’t actually so much concerned on these critical things as they are by reputation (not making fools out of themselves) and scalability (not work too much or hire too many). And it’s not that they’re bad people, it’s simply inherent in their business model.
The VC-business model usually look something like this: they raise a fund with money from other people/companies, which they promise that they’ll invest for a compounded yearly return on 15-20%. In return for doing this, they take a “management fee” of 2-3% of the funds total size, each year. Also, they have some sort of scheme that is based on performance measure, for example 20% of returns above the target rate of return.
But most funds that VCs run actually loose money; I read that there’s some Pareto 80/20-principle going on there… meaning that the VC-industry makes 15-20% yearly return, but it’s the top 20% that actually make up for all the cash that the rest burns through, which conveniently is almost the same ratio as for entrepreneurs. And very much like there are serial entrepreneurs there are also investors that raise multiple funds (“serial investors”? haha), and a majority has raised funds before, very often from the same people you did the last time.
Game theory 101 at work: we have a situation where you as a VC is likely to fail in the long term, but your short term compensation is a function of how many people you have splitting on the management fee. Less people in the organization, means more money for everyone. To make your life easy you choose to go with people with previous experience, since they tend to be a lot less maintenance than young, shoot-from-the-hip experimentalists. Also, you go with “proven” markets, that tend to lower your intellectual / visionary overheads even further 
The other dimension of choosing second-timers and “proven” markets is that if you fail, who would blame you? Certainly not your fund investors… but “These guys did it before” actually improves your odds of success by a meagre 15 percent, which is probably cancelled out by the decreased rate of return… However, oversimplification, dogma and the almighty “no one ever got fired for buying IBM” principle is at work in the VC-business as much as the next industry. Anyone surprised?
