Is Investing an Art or a Science?
by: Amir Gal-Or
It is estimated that there are around 20,000 private equity/venture capital, RMB funds currently active in China. It’s actually quite interesting how large this number is considering that only five years ago there were only just a few. The rapid growth in the industry begs reflection and some analysis. On the one hand it is truly an amazing phenomenon that an industry can go from practically non-existent to a major one in what some would consider a blink of an eye. On the other hand, this same rapid growth is also a bit worrying as it follows a well-known and habitual pattern in China – growth to the point of market saturation and over capacity. That is not to say that there isn’t any room for the private equity/venture capital industry to continue growing, just that it’s better when growth is based on a proper balance between existing professionals and the newcomers who will inevitably experience a learning curve.
In late 2004, when Infinity received the first license ever given in China to establish an RMB fund in the structure of a GP/LP, few in China understood what the private equity/venture capital industry is about - its intricacies and its value. A new system needed to be developed to manage this new industry. This included for example the drafting and adoption of new regulations. A new language also needed to be learned in a manner of speaking: terms like LP, GP, Carry, etc., were totally unfamiliar. Fast forward five years, and regulations are now well established and equity capital/venture capital “lingo” is now well- known by most and commonly used in discussions just about everywhere. Private equity/venture capital leaders have become celebrities in a certain way, and role models.
So, what can we learn from this? First, when something seems to have value in
China and is supported by the government, it scales up lightning fast. We all know that the Chinese are great students and act quickly. This is the good news and the not so good news, as this scale up almost always leads to over capacity, saturation and as a result a dismal situation that more times than not leads to a stream of failures. Why? An introduction of many new comers to the industry in such a short amount of time usually indicates that more than just “professionals” are trying to get in on the action. Many of these new comers have come to the party prematurely. Their interests are more focused on a sense of capitalizing on an opportunity rather than a drive to contribute professionalism and expertise to a promising, emerging industry. Right? Wrong? In the dynamics of the Chinese economy, this may be the right way to go. However, the net result, in my opinion, will inevitably be a high rate of failure.
Against this background, let’s continue the discussion with a review of the ongoing, popular and a most interesting debate: in the private equity/venture capital world, is investing an art or a science? Which school of thought or activity is more important to generating success and sustainability? Do acquired skill sets guarantee success? Or is success more in reach for those who have a strong “inner voice”, a “gut feeling” they can rely on, or if you will, good common sense and a general understanding of people and the interpersonal skills and relationships that result in strong bonds of trust and friendship?
At the risk of dating myself, I’d like to share a story that summarizes how I view the answer to this question. When I took my first steps into the venture industry in the late 1980s, early 1990s, in New York City, l had two mentors. One was Mr. Marshall Butler. He was and continues to be a “people person”. For Mr. Butler, it was mostly about feeling-out the capability of people and estimating personal relationships alongside the facts. My other mentor was Professor Ken Rind. He was all about market research, track records, numbers, forecasts and analysis. I used to say I have the best of both worlds: an art teacher and a science teacher. Who better to learn from? In retrospect and in the overall analysis of which school of thought will more likely lead to success, I would have to say that I believe it’s best to have a little bit of both. Twenty some years of experience later, from my prospective today, I can say having one without the other is like having a half-baked cake. One needs to find a balance between the two, their ying and yang of skill sets and people skills, and exercise both as you approach each turning point and sharp corner.
An example: all three of us, Mr. Butler, Professor Rind and myself, were faced with an Internet deal in the competitive price shopping arena. Professor Rind immediately focused on the technology and numbers related to performance. Mr. Butler immediately focused on the CEO’s background, his team’s motivation and his vision. For me, as an observer, I learned earlier on that the best deals result from when those who exercise these two approaches, though vastly different, manage to somehow arrive at the same conclusion – and thus we have a harmonious marriage of science and art, not to mention a really successful business deal.
When it comes to China these days I believe that only a short list of the existing private equity or venture capital funds have a real ability to exercise the scientific approach. Most of the funds do not have the full skill set to balance all of the aspects. This does not mean that they will not be successful, only that in the long run, they will be unlikely to sustain this success.