Premise: I’m in the midst of preparing a presentation for my thesis defence—practice-session this Friday, and final one on September 5th. My thesis is on how high-tech startups can bridge the equity gap, and I’m still busy every day interacting with potential employers. Love it when my hobby and my “job” work out in synergy!

So what do venture capitalists and employers have in common? Investing in startups and hiring employees can be tremendously fun for sure. You’re funding bright ideas and getting fresh blood into the company. But there is also a significant information asymmetry between the “Investor” and the “Investee.” Both VCs and employees use similar means to overcome that, I think.

The VC investment process

Startups have the problem that they lack a track-record and collateral. So they can’t just walk into a bank. And VCs need to find ways to deal with that. Well, technically, most VCs don’t even bother. Statistically speaking, over 80% of VC investments focus on buy-outs, i.e. established SMEs that are just changing ownership. It’s pretty easy to see whether a project is good or bad in that case, you just have the people-risk to deal with. That attitude is not surprising either, since a VC-fund is typically restricted to about 5-10 years worth of investments, while some really high-tech startups (e.g. in medicine) can take 10-15 years to get out of the red figures. For purposes of this post (and my thesis), I use venture capital as an umbrella term for entrepreneurial finance, which covers a whole ecosystem of investors.

How VCs manage risk is typically through:

• Intense scrutiny beforehand—they analyse the business plan, the team, and possibly exchange information with other venture capitalists;
• And intense monitoring & control during—using staged investments, spreading the risk by syndicating with other venture capitalists, taking seats on the board of directors, and by using compensation arrangements, including stock options.

You can probably see a pattern here already. Since VCs, or rather startups, don’t have the luxury of having a house or similar as collateral, nor having forecastable (just imagined) income-streams, VCs have to rely on judging quality on qualities that do exist: the business-plan, the team, and industry/market-insight. And they minimise their risk-exposure over time, by investing in chunks and making sure that priorities between them and the founders are aligned through contractual and other means.

One important thing worth mentioning is that the best way to minimise risk is to spread it across a portfolio of investments. Again, VCs tend to have this luxury, even if smaller investors (e.g. business angels and friends) do not.

The hiring process

The parallels must be obvious. Employers too have to rely on softer qualities, like CVs, grades, work-history, and all of it hopefully accurate. How employers manage risk is typically like this:

• Erecting high barriers to entry—relevant work-experience, good grades, etc.
• Prolonging the application process—erecting multiple hurdles, which applicants must pass.
• Using monitoring & control tools during the employment-period

And, also spreading the risk across multiple applicants! Again, I think, the term “employers” should be qualified: there are large companies, with well-established risk-reducing (or quality-enhancing) procedures, and smaller/younger ones, with less of a history and less resources to dedicate to this.

I do think that startups can find pretty creative ways to deal with it. The primary one, which I have found here in Europe, is working with interns. I think this works pretty well for a certain segment of employees, as long as it’s combined with a proper motivational structure! The other one which I like, is encouraging entrepreneurism from the start. There is no net to catch you if you fail in a startup, and by having applicants show that they have this attitude even before they are hired, you ensure a certain alignment of priorities. Note: I think this perhaps works better for business-applicants, correct me if I’m wrong! I think it was Seth Godin that once wrote that the best way to hire a person is to just put them straight to work and see how they do. That’s your application process right there!

You can employ techniques from VC-investing after hiring someone as well: using a staged approach (which is typically an internship and/or trial-period), monitoring (in a nice way, I hope), and motivational tools. I think the one major difference between VCs and employers is that there is less “psychic distance” between the latter and their employees. VCs, while being considered active investors, can still get away with weekly or monthly contacts. Employees are exposed to the company every day, requiring a more human relationship. Just my opinion!

Regarding motivation, I like the idea of empowering employees, which I wrote about on my old blog before, and I’m also wondering in general about the effectiveness of stock-options vs. other motivational means. Certainly, considering the recent exit-unfriendly climate, people have become more sceptical about stocks. At the same time, I personally think that people work a little harder if they are working for themselves. Again, correct me if I’m wrong!

What are some creative ways to hire employees, do you think or have you experienced?

Vincent

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