Baseball, the "Steroid Era" and Venture Capital Returns
Baseball, the “Steroid Era” and Venture Capital Returns By Tom Tierney27 January 2011It is the dead of winter, but believe it or not, baseball spring training is right around the corner. Withdreams of baseball in mind, I thought it might be appropriate to visit baseball’s unique connection toventure capital, or early stage company investing.Interestingly, if you look at baseball statistics from MLB.com (Major League Baseball’s web site), a groupof great all time hitters from the pre-“Steroid Era” compare relatively the same as a representativegroup of their era: Pre-“Steroid Era” All Time Hitting Sample Player At Bats Hits Homeruns %Hits %Homeruns H. Aaron 12364 3771 755 30.50% 6.11% B. Ruth 8399 2873 714 34.21% 8.50% W. Mays 10881 3283 660 30.17% 6.07% T. Williams 7706 2654 521 34.44% 6.76% All-Average 9837 3145 662 31.97% 6.73%Roughly, 30% of the time these batters came to the plate, they got a hit: single, double or triple etc.Roughly 6% to 7% of the time these greats came to the plate, they hit the ball out of the ball park, a“home run”.Similarly, an early stage investor, like a baseball player, is also doing very well if he or she gets a “hit”30% of the time. A “hit” might be a return of 1X to 5X their invested capital. In a portfolio of 10 to 20investments, a “home run” might happen 10% of the time and those 1 or 2 home runs will producereturns that will cover all the other investments, and more. I suspect that 10% home run percentagemay well be closer to baseball’s 6%-7%, but unlike baseball, early stage investing doesn’t have a processto openly track results.In the “Steroid Era” of baseball, some players used performance enhancing substances to increase theirmuscle mass, reaction time and ultimately, their bank accounts. These players got larger returns on this“investment”, increasing their home run production and fan interest in the game. Players, team ownersand even the general public were happy, until the truth came out, and the music stopped.In the “Dot.Com” time period, the “Steroid Era” of venture capital, some early stage investors changedtheir investing criteria for investment to increase reaction time to funding, increase the size of theirfunding and ultimately, increase their bank accounts. During this era, early stage investors put money in
a business to “grow big, fast” with some businesses never initially validating whether “the dogs will eatthe dog food”. Investors, companies and even the general investing public were happy, until the truthcame out, and the music stopped.OK, how about that “Steroid Era”? Well: “Steroid Era” All Time Hitting Sample Player At Bats Hits Homeruns %Hits %Homeruns B. Bonds 9847 2935 762 29.81% 7.74% S. Sosa 8813 2408 609 27.32% 6.91% M. McGwire 6187 1626 583 26.28% 9.42% R. Palmeiro 10472 3020 569 28.84% 5.43% All-Average 8829 2497 630 28.28% 7.14%The hitting percentage of the pre-“Steroid Era” sample at 31.97% beats the “Steroid Era” 28.28% samplebut the “Steroid Era” leads slightly in home run percentage with 7.14% to 6.73%.It isn’t so much the percentages, they are all relatively close, it is the “era” in which the results wereproduced: baseball’s “Steroid Era” rewarded this extra home run production with higher salaries,players got more product endorsements and generally got a better return on their “pharmaceuticalinvestment”.Likewise, early stage investing had higher returns during its “Steroid Era” as companies funded with littlemore than a “Dot.Com idea” were the subject of M&A or IPOs, having never proved a business model.Early stage investors were rewarded for these “home runs” even though the environment of this timeperiod was equally artificial like baseball’s “Steroid Era”.Unlike baseball, most individual early stage investors and venture capital firms don’t discover theirhitting percentages or home run percentages until many years after “coming to bat”. The average timeframe for an investment to exit is 5 to 10 years, or more . Those investors who had their “at bats” laterexit to “hits” or “homeruns” during the “Steroid Era” were paid handsomely for their timing. Thoseinvestors who “came to bat” during or after the “Steroid Era” will probably have results following thepercentages presented above, however, like baseball, those homeruns just won’t pay off like they useto.Yet, early stage investors, like baseball players, still love to play “the game”.Tom Tierney lives in Encinitas, CA and is a member of Tech Coast Angels (www.techcoastangels.com).Also see http://en.wikipedia.org/wiki/Tech_coast_angels for more background information on the TCA.