In Defense of the Venture Capital Herd Mentality

Every few conversations about venture capital, someone laments the “herd mentality” of the venture capital sector.  That is, the tendency of venture capital investors to invest in similar areas.  It’s a favorite topic of cleantech afficianados as well, both before cleantech got hot, and since then.  I’d like to ask though, are we sure the herd is a bad thing?

I’ve personally invested in and raised money for companies in hot areas, in passe sectors fallen well out of favor, and in sectors way before their time.  And while part of me would love if all investors always liked my deal, and all companies wanted to sell to me cheaply because no one else was interested, the other part respects that the herd mentality probably exists for very good reasons.  Maybe it’s just a form of better managing risk and creating value.

A couple of reasons why a herd of venture capitalists may not be bad:

  1. Supply chain / ecosystem development – It’s always rough for a new technology company to have to develop everything itself.  The herd or trend investing typically means if you are investing in or building a company in a hot area, there are more resources available to help.  More suppliers.  More partners.  More customers.  (Even more bankers and lawyers and accountants that don’t look at you funny when you use jargon.)  More innovation.  More collaboration.  More of all of them investing in parallel.  Better predictability in planning.  Better predictability in exits.
  2. Capital accumulation – The whole concept of the joint stock company helped advance the entire idea of capitalism, and the industrial revolution, buy creating a way to accumulate capital of an appropriate level at an appropriate pace for the next ventures.  Venture capital syndicates provide the same type of value, enabling pooling of resources, sharing of risk, and staging of capital and risk, in a predictable, long run, sustainable way.  Let’s give them credit.  The herd might be just a symptom of a sophisticated capital accumulation system working well, as opposed to a cause of a malaise.
  3. Scale matters / changing the world matters – Let’s assume part of the point here is for innovation to change the world and make it a better place (I’d like to believe that).  In cleantech for example, the underlying sectors are so massive that a few investors and a few companies are unlikely to make a dent before I retire.  They’re going to need billions, and build things that make skyscapers look small.  Maybe it takes a herd.  In this view, once an area of game changing innovation is identified, don’t we want to see it fly and scale? Like, now?  If we think we’ve got the next big thing in our sights, how about making sure the whole world focuses on it?  Oh wait, that would be the herd.
  4. De-risk future fund raisings / recruiting – One of the big risks for both investors and startups is recruiting top talent and raising the next round, ie not running out of money just when you’ve figured out what to do.  When was the last time you tried to do either of those in a sector that didn’t have dozens of funds hot after it?  That really sucks.  The herd mentality has a hugely positive impact on derisking a startup launch and derisking the staging of capital needs for both founders, investors, and customers.  Think of the valley of death concept- the other favorite complaint of all startups.  Good herd management means a bridge over the valley of death (albeit often a creaky one!)

In the cattle business, cows by themselves away from the herd are a double edged sword they mean 1) you’re about to have a calf, or 2) you’re about to have a problem.  I think we should remember herds aren’t all bad, they generally exist to protect and nurture.  That’s why lion prides out compete cheetahs, and why wildebeests survive the Serengetti migration, right?  Yes, that creates trade-offs, and there are plenty of approaches where the herd is the enemy of the innovation.  But don’t ding the herd out of hand.  Respect the power of the herd.

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