Patricof shares three decades of VC wisdom
Entrepreneurship: Lessons from the Past... Opportunities for the Future
Jaideep Singh, WG 02
Issue date: 11/5/01 Section: News
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Wharton Journal: How did you get into VC?
Alan Patricof: Before there was VC, most investments were made by wealthy families. Early in my career I began managing investments for wealthy individuals. I learned about investing in private companies, and was exposed to the business. By 1968, given the favorable legislative environment for investments, I went out on my own, raised a fund, and began investing in early stage private firms in New York.
WJ: As one of the pioneers of the VC concept, why is it that this investment model was born in the US, and not elsewhere, like in Europe or Japan?
AP: Thirty years ago, or for that matter even 15 years ago, VC and entrepreneurship, as we know it, did not exist in Europe. There are many reasons for this, but most importantly it was cultural. Failure in Europe was viewed as career ending, whereas in the US the penalty for risk-taking and failure has always been low. Early failure was viewed as a badge of honor - it’s like you’d been to war and survived. Also, society and organizations in Europe and Asia were very hierarchical, making career mobility harder.
Besides cultural differences, the IPO market was not as attractive as in the US. Moreover, equity ownership by management and employees was almost non-existent, making the payoff unappealing. Hence, incentives for entrepreneurs and investors were low.
Other factors in favor of the US were: a large number of well funded research Universities, Business Schools, and well developed legal structures, accounting systems, and capital markets. These factors contributed towards creating technical and business advantage.
WJ: Why did you enter Europe in the early 70's before any other VCs?
AP: I could see it. The capital markets and stock exchanges were starting to liberalize and develop, creating the right environment for successful IPOs. Although recently there has been a quiet rationalization, a slow retreat from Europe and Japan; this was a great opportunity to start investing in Europe, and other countries.
WJ: They say that VCs have an uncanny ability to spot opportunities. What, in your mind, are guiding principles?
AP: Don’t say uncanny – that is giving us too much credit. We violate our principles all the time. However, there certainly are a few guiding principles. We look for a fully informed management team that not only understands the fundamental economics and cost structure of its business, but also understands its industry well. You’ll be surprised how many teams fail this test. There is a big difference between understanding the market you are in versus the firm’s addressable market.
Moreover, a great team with a lousy product has a better chance of survival than vice versa. I love to see a group of people who have worked together successfully in the same industry. This alleviates many risks.
Besides the management team, a business should have some form of “unfair competitive advantage” – either a more favorable supplier, or fixed customer contracts, or key patents – things that allow them to sell a product at a better margin. This allows the firm to plough back more into their business, thereby allowing them to grow faster than their competitors.
On the flipside, it is also important not to be so far ahead of the rest that you end up educating the market – a very costly affair that forces first movers to fail and allows later entrants to come in and take over the market. Lastly, it is critical for a business to be adequately funded.
WJ: What are some of your greatest achievements?
AP: You can look at the Apax website to see the list of successes like AOL, Apple, Fore Systems, Bluestone software, Office Depot, Yell, Johnny Rockets, etc. However, one of the investments I personally liked a lot was Cellular Communications Inc., back in 1981. We backed a great team which was successful, and later spawned five other companies. Of these five, we backed three and two were winners. These were Cellular Communications of Puerto Rico, and NTL.
WJ: What are some of your biggest mistakes?
AP: That is easy. Starbucks. We didn’t spend enough time understanding their positioning and economics. This was also at a time when there were two cafes on every block in New York. We just didn’t take the time.
The other was Dell Computer. We didn’t believe that you could sell efficiently over the phone. Added to this was the fact that Michael Dell was only 21 at the time.
Beyond these two, there are too many too list. We backed the wrong teams, and also ideas that were way too early, with high market education costs.
WJ: What advice did you give your kids, who are the same age as the average Wharton MBA?
AP: First, don’t work for you father, and don’t rely on your family for getting you jobs. Second, go with your instinct, that is, do something because you feel it’s the right thing to do. One of my sons works in media and entertainment, and another is going into private equity. They both live in New York, and did everything themselves.