Q: Why do you think the venture capital industry has the qualities of being a profession?
Well, I'm slightly speculating in the sense that I'm not a doctor or a lawyer or an accountant, but as far as I am aware, all of those professions have bodies that try to maintain professional standards in the industry through self-policing. The important word is "self-policing" of professional conduct. Now, that doesn't mean that those standards are followed by everybody and it doesn't mean that the actual "name and shame" process works as effectively as it should at all times. Nevertheless, it is a pretty powerful remedy for poor behavior that is beyond your basic lawsuit and contract performance.
Although it's not as strict for venture capitalists here, we are self-policing in the sense that there is an association that invites you to be a member—though it's as a group, as a firm. We've not gone to the point of actually accrediting individuals. There is an attempt by the industry to maintain a set of professional standards, a code of conduct, and the industry is small enough, still, that if really egregious behavior emerged, it would be quite quickly stamped out. And that's the power of having these associations to which firms belong.
Q: So, what is this code for venture capitalists in the UK, and to whom do you owe an obligation? Is it primarily a fiduciary obligation?
You absolutely have an obligation to your investors—that's for sure. That is your fiduciary obligation. You've taken money from them as a blind pool and, because of limited liability, they have very few powers to get it back, so it's very much a position of trust. I think that is the overwhelming obligation, but there is a secondary obligation to our regulator, the Financial Services Authority, that we conduct our business in a certain way, with certain explicit standards with regard to conflicts of interest and personal conduct.
I think the last obligation is to be a good partner. Our industry is one in which deals are syndicated all the time and your ability to build syndication is a function of how you behave. Whether you've got deep pockets and the know-how to do the analysis, and whether you're rational, and whether you work hard are all certainly factors. But, at the end of the day, that's all taken for granted. The issue becomes, given that we're in a high-risk activity, how will you behave when things get tough?
That becomes a major discussion as to who you invite into a deal. I don't know what the right analogy is—whether it's mountain climbing or life boats—but because the entire investment could be at risk depending on the behavior of your co-investors, their pattern of behavior matters. Those funds that think this is a singular game or singular roll of the dice and maximize their return on a single event lose out, because this is a serial game over the long run, where there are many rolls of the dice. We often have a very clear discussion about reputation, which is: If we behave like this, what will this do to our reputation? And all the good firms maintain very high standards because of that.
Your reputation is built on conduct—behavior over a long period of time. Investors seek stability in a firm, and we have to conduct our business for the long run. I mean the very long run. Many individuals in the industry, and many small teams, have 25- or 30-year track records. That's very, very different than corporate executives, whose half-life is about two years.
Now, there are elements of all of this in management as a whole, when you look at what it means to be a company director and how governance works, but I don't see it as a profession.
Q: It sounds like part of why this works in your industry is that it's a relatively small community. You can easily know the reputation of the other members in the community. Is that why you're skeptical of applying these kinds of ideas to management as a whole?
Yes, yes. And it is also this issue of half-life. I mean, executives don't stay their whole careers in companies. There are recruitment processes and career building from one position to another that almost encourage mobility between corporations and from industry sector to industry sector. I'm sure that by the time you get to very senior positions, the group of executives that could manage multi-billion-dollar businesses is actually quite small, and their reputations are well understood by that time, but that's the tip of the iceberg for what you'd call management.
I'm in the UK, and the whole venture capital industry is about 170 firms. Turn six degrees of separation into two. I would be very surprised if there are more than two degrees between any two people. So, it takes literally two phone calls for me to check out anybody.
I was going to say it might be the same in hedge funds, but I think it's not. I've actually done some European work with the hedge fund task force and the private equity task force, and the European Commission noted how different the cultures were between the two groups, because hedge funds are at each other's throats and we were trying to find a solution.
The real difference is that almost all hedge funds—not the ones that are now doing private transactions, but the ones that are working in public markets—are buying and selling against a counterparty, and the whole point of a counterparty in the market is that it's anonymous. So you're watching the market. You're watching the price move, you're making a trade, and you do not know who's on the other side of the trade—that's the whole point of the market.
Everything we do, we know who's on the other side of it. We know the impact—whether it's the current investor or whether it's an entrepreneur or whether it's ultimately the exit by trade sale—so we're not dealing with an anonymous market. There may be a market price, and that's clearly an arm's-length transaction. But it is highly transparent in a negotiation how you have structured the deal, how you conducted yourself all the way along, and that becomes part of your reputation. That's the nature of private transactions. The fact that we do co-invest together means that you'll be competing in one situation and you'll be co-investing in another situation, and you've got to be able to handle both sides of that well.
Q: You were the chairman of the British Venture Capital Association. Is that the professional association you're describing?
Yes. That's the body that started about the same time as the industry evolved in 1983. It has lots of interfaces with the government, in terms of trying to improve transparency and, at the same time, arguing that a light touch is appropriate to a professional industry that has professional relationships between institutional investors and the professionally managed funds.
Q: What did you work on as chairman?
My priority was to help harmonize valuation guidelines and to internationalize them, because we had several approaches in Europe and there were many more globally, and investors were just throwing their hands up in horror, saying "We can't make any comparison between funds, because you don't value things the same way. We spend all of our time trying to figure out how you calculate, and would you please sort it out." And we did. We got the French, the British, and the European associations together, which was really quite an achievement. We built a consensus across Europe and then quite quickly we got South Africa and Australia and Canada and Israel to sign up. The only place we haven't got signed up is the U.S.
Q: It sounds like one of those situations where it's in everybody's interest to cooperate, but it's hard for one individual to push for it. It takes consensus.
No. It took leadership to do it. You have to get the debate above the egotistical question of, are these British or French or European standards? In fact, we spent three months debating the title and eventually decided on "International."
It's the same in any standards body. It's done in electronics all the time. Once standards are set, then it is possible for industries to accelerate their growth because everyone's working to the same standard, and then competition is no longer between standards but between real performance metrics.
Q: Is a part of your long-term record, in addition to the way you have behaved, the companies that you've supported that continue to live?
Yes. You sell out and that's your job. You've got to return the money to investors. But you've created the DNA of a company that then thrives and then spawns other companies and that changes the culture. For example, Cambridge Silicon Radio was founded in 1999, a spin-out of a technology consulting firm in Cambridge, went public in 2004 on the London Stock Market, and is worth a couple of billion now.
They develop Bluetooth chips for mobile phone headsets, among other applications, and it is a magnet for talent in Cambridge. Having a company grow and thrive in its full potential, with all of the leadership here in the UK, just creates one more iconic story that people look to and say "I can do that."
That makes a big difference, whether it's inside our team or it's a bunch of engineers wandering around or a bunch of financiers wandering around, all saying, "Let's create the next Cambridge Silicon Radio," which is fantastic.
So it has intangible value for the community as well as real value in terms of cash return to investors.
Q: How much do you think about creating those kinds of intangible values when you're first looking at a potential project?
We don't. Except that, well, we do in terms of the scale of the opportunity. If there isn't a very high-growth story, it's not a venture capital deal, full stop. But that's actually very rational financial decision-making. Unless there's at least 10 times your money, it's not a venture deal. There are lots of good things that could be done, but it's not a venture deal. That's what we're in business to do and that's what we need to deliver to our investors.
The secondary issue is, once you're in it, how do you maximize value? If maximizing value by creating a stand-alone company is a valid and high-potential path, then we'll support it, but I think the micro and immediate optimization of value for our investors has to come first, and if it's rational for us to sell and get cash, we'll do it.
The reality is that an awful lot of very high-potential businesses are better standing on their own two feet because, if they're truly disruptive, there isn't an obvious buyer because there aren't any synergies. They've actually developed an entirely new market or business model and are creating true new value. So, if we are disruptive in the kinds of companies we back, then we're often creating industries, we're not creating companies. And then, your choice has to be ipo, because nobody understands what you're doing. So that's the way it works. Your responsibility to your investors comes first.
Optos is an example. It went public on the London Stock Exchange in February 2006. In that case, the founder's son went blind in one eye. He basically built a better mousetrap, a retinal imaging device in this case, so that no one would have to go through what his son went through when he was being tested for his sight. They just reported $67 million revenue and estimate a $2 billion market in revolutionizing eye care. And why is that important? Well, it's important because it will create value in a number of different ways—for a patient, for optometrists, and obviously for Optos itself—but also because it's creating a market. It has a $2 billion maximum market with no competition because it created something from nothing. There was no market to go and study. There was no analysis that would have told you that this was something viable. It was entirely vision. I think that is the highest return form of venture activity—to effectively create an industry, not just businesses.
Interviewed by Jonathan T.F. Weisberg