An extensive study conducted by Geoff Smart in America [1] established a clear link between an investor’s approach to human capital valuation and the deal success. Yet, somewhat surprisingly, it was found that the best practices were used less frequently by VCs than the worst practices, indicating opportunities for improved IRR through more effective human capital valuation practices.

The study identified several different approaches to evaluating management, which he named as follows:

  • Airline Captains are systematic and thorough in their collection and analysis of data, the way that an airline captain conducts pre-flight checks. They base their analysis on data rather than just intuition.
  • Art Critics make snap judgments based on intuitions. They think they can assess a person quickly, the way an art critique judges a painting.
  • Sponges soak up data in a non-systematic way and then analyse it unsystematically.
  • Infiltrators try to become a quasi-member of the management team. They spend many weeks or months partaking in planning meetings and even visiting potential customers together with target managers prior to making an investment decision.
  • Prosecutors aggressively question the target managers in a formal setting, the way a prosecution attorney questions a witness.
  • Suitors are more concerned with wooing management than assessing them, so they spend time trying to make a good impression rather than critically evaluate the management team, and
  • Terminators are convinced that it is impossible to achieve accurate human capital valuations.

As a result of this study Smart determined that venture capitalists who used the airline captain approach to human capital valuation achieved by far the highest average IRR, but surprisingly only 13% of venture capitalists used this approach!

1. Smart, G. H. (1999) Management Assessment Methods in Venture Capital: An Empirical Analysis of Human Capital Valuation, Venture Capital, 1, (1) pp 59-82.