“A GREAT management team will find a good opportunity even if they have to make a huge leap from the market they currently occupy.” Thus Arthur Rock, a legendary figure in the venture-capital (VC) industry who has argued that it is more important to find outstanding management teams than to try picking winning businesses. His track record, which includes backing the creators of Apple Computer, suggests Mr Rock's belief that first-class entrepreneurs are what matters most to start-up success has much to commend it.

With tougher economic times looming, it seems an especially good time to put one's faith (and cash) behind an experienced management team with a history of success. Of course, investors ideally want to back firms that have brilliant managers and a brilliant business model. But some venture capitalists favour the former.

The view that excellent leaders can make the critical difference to a new company permeates the classroom as well: ask any gathering of MBAs if it is the business “horse” or the management team “jockey” that matters most in an investment appraisal and a sizeable number of students will pick the jockey (perhaps because they fancy sitting in the start-up saddle themselves one day).

Yet a new study* shows that in the real world most venture capitalists put far more emphasis on the runners than the riders. The study's authors—Steven Kaplan of the University of Chicago Graduate School of Business, Berk Sensoy of the University of Southern California and Per Strömberg of the Swedish Institute for Financial Research—look at a sample of 50 firms backed by ten different VC companies, examining their early business plans and then tracking their performance through to initial public offering (IPO) and several years beyond. Most of the early-stage business plans they scrutinise were produced between 1995 and 1998 by firms from a range of different industries. The biggest sector was biotech, which accounts for 17 of the firms.

The research shows that during the period the academics studied—typically from three years before IPO to three years after—only one of the 50 firms changed its line of business and none made acquisitions in areas outside their core activity. In other words, the horses pretty much stayed on the same track.

But the jockeys often changed. At the end of the period covered by the research, only 44% of the CEOs were the same ones involved at the time that the initial business plans had been drawn up. There had been significant turnover among other senior executives too, such as the chief financial officer and chief marketing officer. The implications of this are clear: investors are far more likely to change a firm's managers than its strategic direction.

To test the validity of their findings, the researchers studied all American IPOs that took place in 2004. After removing flotations of closed-end funds and other financial investment vehicles, they were left with 106 offerings, 88 of which involved VC-funded companies. Again, they looked closely at the IPO prospectuses of the firms and at online databases of business news to see if they could identify any significant shifts in their business models. And again they found that only a handful had strayed from their early business plans.

The companies were far less faithful to their original leaders: over the period covered by the research, half of the chief executives were replaced by the firms' owners and only a quarter of the other senior managers remained the same. Such turnover does not mean that managers are irrelevant to a successful start-up: after all, the new CEOs in the sample were given an average of 4-5% of the equity in the firms that they were brought in to run, which is proof of their value. But it's clear that most venture capitalists don't consider them the vital factor in a winning business plan.

Indeed, many well-known investors have minted money by backing start-ups in markets they think have explosive growth potential, even if the firms' managers are not seasoned hands. Take, for instance, the example of Donald Valentine of Sequoia Capital, a leading Silicon Valley VC company. In 1987 he encouraged his firm to invest in a little-known start-up called Cisco, even though the company had been shunned by many other investors who thought it had a feeble management team.

Looked at another way, there is scant evidence that a brilliant management team can take a lousy horse and turn it into a race-winning champion. As Warren Buffett, the Sage of Omaha, likes to remind his many followers: “When a management team with a reputation for brilliance backs a business with a reputation for bad economics, it is the reputation of the business that remains intact.”





“Should Investors Bet on the Jockey or the Horse? Evidence from the Evolution of Firms from Early Business Plans to Public Companies”, by Steven Kaplan, Berk Sensoy & Per Strömberg. Forthcoming in the Journal of Finance.