The question of value add and differentiation between VCs

The age old question remains if in fact top tier venture firms actually add more value to companies after the investment or if they pick the best investments which just have a high chance of getting a greater return. Is it a product of deal-flow, selecting the right companies, and value add post-investment or some combination? To that end, what constitutes value-add?

Most biotech venture capitalists were not CEOs of companies, either small biotechs or large pharmas. How then can they advise CEOs on what to do in certain situations? Clearly holding board seats on many companies allows them to see multiple different scenarios and learn from experience. Why then is not every VC who sits on many boards able to offer the same advice? Most VCs are not expert drug developers and thus opining on clinical trial design often will not be productive beyond what a domain expert at the company can produce. So what then is the value added?

I propose 3 different areas on which VCs can differentiate themselves and add value:

  1. Network – A VC with a broad based and deep network is worth significantly more than one with a less broad network. Attending VC/pharma/biotech networking conferences is one way to build this network. Age by simply being older allows you to accumulate more contacts. Working at a large pharma/investment bank/PhD lab/medical school/etc can enhance a network. Being proactive and having many breakfasts, lunches, and dinner with different people in industry is clearly another way to establish relationships. Eventually your reputation gets to a point where people seek you out instead of you proactively approaching people. It starts to feed on itself. The major focus of my time in business school was learning how to establish relationships as a way of differentiating myself.
  2. Due diligence – There is a wide range of due diligence that a VC can do on a particular deal. Clearly there is a constraint on the amount of money a VC can spend on due diligence, which is tied to the size of the investment (e.g. you won’t spend $500k on diligence for a $5M investment). Hiring the appropriate industry consultants to review data, assess probability of success, discern the real market opportunity, making reference calls on the mgmt team, the right IP firm doing a freedom to operate, etc, etc can really make a deal. Interviewing physicians in a particular area also can speak to the receptivity of the product and how it will fit into clinical care. Some firms do a lot of quality diligence and other firms piggyback on other people’s diligence. This area is largely a function of how much an individual firm prioritizes this part of the investing value chain. This aspect of differentiation is largely applicable to LPs and not companies but access to this due diligence network once you are a portfolio companies can be quite value added.
  3. Business/corporate development abilities – A VC which understands business and corporate development can give significantly better advice to companies than VCs that do not. Just because you were a former investment banker does not automatically make you qualified on this front (based on my experience in banking, there are a lot of dumb bankers). How business development strategy fits into fundraising strategy, and how those both fit into exit strategy is critical. The network of a VC into the potential licensees or acquirers definitely helps in this area. Company strategy and company positioning is crucial. A lot of smart VCs can give completely contradictory advice and knowing which VC to follow can be difficult. A VC can really differentiate here with their prior experience and track record. This is partially why I decided to do investment banking and business development at both large and small biotech companies to acquire this skillset.