Myths

10 Investor’s Myths Busted

The other day I was invited to a lunch time seminar with Thomas Thurston with the stimulating title of “Growth Science”. I’m a fan of statistics and what they can teach us about the world about us – some time ago I noticed a correlation between investment and high standard deviation of pitch marks. I’d love to know if the correlation extends to exits too. But that’s another story. Back to Growth Science.

I’ve been looking out for ways to apply science to work out how to make good investment decisions. The opportunity to hear from Thomas Thurston who has extended (and used to work with) Prof Clayton Christianson work with hard evidence to support decisions was too good to miss. Thurston had studied 3000 companies from around the world to see if he could debunk some myths and work out some useful patterns. He must be doing something right because he said his Venture Fund based on the work is in the top 1% of performing funds in Silicon Valley.

So what are the myths and how did looking at 3000 companies to see how many got past their 10 year anniversary help us?

The results are in… and these are the ten myths that been debunked by evidence:

  1. Learn from winners (study success and emulate it). If you don’t look at the failures as well how will you know what the elements are attributable to success? Take an extreme case; if the office of the CEO of every successful company has a Yukka plant in it, then you should install a Yukka plant because it will make you successful. However if you look at failures and discover the CEOs of failures also have Yukka plants you can discount that attribute.
  2. Focus on the team. The statistics suggest that the team only make up for a variance of around 12% in the success rate. What appears to be important is that the team has minimal competence, in other words, “back the horse not the jockey”.
  3. What’s in the company (excluding persistence) matters more than what’s outside the company. The research showed that the same proposition (i.e. we are producing something better than that which already exists) has a 64% chance of success if you are working in an incumbent but if you are trying to break into the established market, this drops to 13%. What is outside the company has a nearly a 5x impact on success.
  4. Locate your business in the right place (i.e. Silicon Valley). Statistically there is no difference in chances of success of companies inside Silicon Valley and the rest of the USA – the proportion of Venture Capital exits is the same – 10%. What skews people’s thinking is the sheer number of companies starting meaning you would expect the absolute number of successes to be higher in Silicon Valley. This does not mean your chances are better.
  5. Big change is usually generational (ex. Jobs, Zuckerberg, Gates). The average age of a successful start up founder is 40 – that’s middle age!
  6. Build powerful financial models. The ability of financial models to predict success is demonstrated by the number of companies that adhere to them in the first six months: approximately if not absolutely zero.
  7. Find a hot market that’s growing fast. Hot markets are the worst place to start a company – there is far more competition reducing the chances of success of any individual. Take the extreme case, if you start the only company in a new market you have a likelihood of success of 65%. If there are two companies, that halves… ten companies… hundred companies…
  8. Make sure your product is better than anyone else’s. Statistics demonstrates that survival rate based on this strategy is around 13% for a new market entrant. For companies starting in a low-end r new market, the survival rate increases to 65%. So if you’re new to the market then being better is not a good predictor of success.
  9. Statistics are for losers, it’s all about guts. Growth Science claim to have correctly predicted successful start ups more than twice as effectively as in the wild using statistics. Their fund based on the predictions is in the top 1% of most successful funds…
  10. Trust your intuition. Which myth did your intuition tell you were right?

So what? There are two clear conclusions for me:

  1. If you are an investor; read up about statistics and learn how to apply them. Watch out for when you apply a myth to an investment.
  2. If you are an entrepreneur; make sure your presentation includes each of the ten myths since then you are likely to snag the greatest number of investors!

What are your conclusions?

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