Why VCs Should Think More Like Warren Buffett

Adam Ludwin Jan 24, 2011 Back to blog

In public market investing there are two dominant strategies:  growth and value.  Growth investors look for fast growing stocks and pay a premium to participate in the upside.  Value investors, in contrast, tend to focus on the fundamentals of a business, the so-called intrinsic value – and then try to pay less than that for the stock.

Everyone knows the name of the most famous value investor, Warren Buffett.  But how many people can name a famous growth investor?  The fact is that, in the public markets, value investors are typically hailed as the intelligent, diligent, and thoughtful investors.

The opposite appears true in venture capital.  It is the ultimate growth investment vehicle.  VCs that see trends early become the stuff of legend. They become known by the marquee company they spotted before anyone else.  In contrast, investors who spend time thinking about whether a given financing round’s valuation accurately reflects the fundamental value “just don’t get it.”  After all, it could be the next Facebook!  And to be fair, this is an economically rational position in an asset class where a single position can double or triple an entire fund.
 
But simply piling on the latest hot trend is not a recipe for great returns.  Neither, unfortunately, is investing presciently in a company that is before its time.  Even in rapidly expanding markets, there are typically huge differences in valuations between the leading company and everyone else.
 
The truth is, the best VCs act a lot like value investors.  They think deeply about intrinsic value.  In an early-stage venture context, this is often a conceptual exercise, but is no less real than for later-stage companies.  It comes down to whether the business creates value for its customers, can profitably capture some of the value it creates, and can erect lasting barriers so others cannot erode that profitability.  If a business like this exists in a big, growing space, and is raising money at a reasonable price, it is an excellent investment candidate.
 
Successful VCs have to both identify trends and determine the intrinsic value of the business opportunities the trend gives rise to.  Many can do the former, fewer can do the latter.
Entrepreneurs should seek investors who think like value investors.  They should want a financial partner that understands their business and what it takes to drive growth, not one who was interested in the company when it was hot and will become distracted as soon as the next trend comes along.
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