I’m a sucker for analogies between sports and business. With Barry Bonds on the cusp of tying Hank Aaron’s homerun record, the issue of steroid usage is front and center in sports. That got me thinking about “performance enhancement” in the venture capital business. In other words, how do you transition from “safer” investment strategies to ones that provide more upside?

The suspicion of Barry Bonds has a lot to do with his transformation about ten years ago from an average power hitter to the most dominant power hitter of our generation. In his first ten years as a player, Bonds averaged more doubles than homeruns (31 compared to 29). During the next ten full-seasons, that ratio inverted sharply (28 compared to 44). In baseball, hitters possess different styles. Three common varieties are singles hitters, doubles-hitters and power-hitters. One is not necessarily better than the other (though prestige, compensation and star-value will vary widely). These styles of hitting are fundamentally different meaning that almost everything the hitter does to become proficient at the desired approach will have to be tailored. Pitch selection, the mechanics of the swing, the weight of the bat and the physical regimen are some important factors. While players are developing (typically in the minor leagues of the first few years of MLB experience), there’s possibility of transition from one style to another. But deep into one’s tenure as a professional, the transition is almost unheard of. This accounts for much of the circumstantial evidence people gravitate toward in the case of Bonds and alleged steroid usage.

But what about the venture investment business? Can someone make the switch from one investment style to another? It’s a relevant question to ask because today’s investment climate for web ventures provides strong incentives to be the venture equivalent of a doubles-hitter.

Before we consider the question, it’s important to review general parallels between styles of venture investing and hitting a baseball.

In baseball, there’s no single way to be productive as a hitter. A player will settle into an approach that meets his skills and capabilities. The same holds true for disbursing investment capital. A high probability of singles and doubles can be equally rewarding as a more infrequent number of homeruns (IRR doesn’t discriminate). Like other investment disciplines, the venture business is about developing perspectives on risk and rewards. If you’ve ever pitched a venture investor, you can often see how their questions and evaluation of your company are focused on isolating elements of risk and reward. Risk is typically partitioned into buckets – team risk, technology risk, product risk, market risk, etc – whereas reward is thought about in terms of levels of success (how big can this company be in a high, medium or low case). There’s a lot of ways to play this matrixed analysis, but one simple way to bucket the venture community (recognizing there’s gray area) is to think about Risk-minimizers and Reward-maximizers. Every venture capitalist mixes both outlooks, but there can only be one style that predominates. That’s the issue we’re concerned with here.

Risk-minimizers have a lower bound for possible upside. That’s a very pragmatic strategy which offers a lot of protection and is a good reflection of the law of averages. For a web business today, this might be an exit valuation in the $20mm-$30mm range. Like any investor, Risk-minimizers would love to see their portfolio companies exit in the hundreds of millions, but they’re not depending on it. After qualifying companies for this upside filter, Risk-minimizers turn their attention to their specialty. Here they start to size up the risk factors. The more risk factors, the less likely they will be to invest. The extent of the risk surrounding any given factor is an equally important set of considerations, though risk-minimizers may pay less attention to that dimension than the absolute number of risks. Let’s consider some straightforward examples. Team-risk can stem from a lacking someone to fill a key role (CTO or VP/Marketing) depending on the nature of the business. A higher bar for team risk can involve not only the fit of a particular person in terms of credentials (CTO of a search company having a higher level degree in a related field) but also a specific track-record (say a leadership role in commercializing a successful product). Technology risk speaks to basic feasibility. Is something even possible to do within acceptable parameters for scalability, performance, relevance, response-time, etc? Product risk, on the web, has mostly to do with whether a cohesive user experience can be conceived and delivered using the underlying technology. Finally, market risk is exactly what it sounds like. Will they come and will they care?

By contrast, there are investment opportunities on the web with more fundamental risk profiles. That does not make these types of investments better or worse at face value. These risks can include basic technical feasibility or the need for clarity on application focus. But these risks can be managed to some degree by isolating the critical design issues and strategies (in case of technical hurdles) or possible use cases (in the case of application-direction). With today’s rapid customer feedback loops and iterative development cycles, the ability to try several options quickly is also compressing that risk. Provided there’s a multiplier on the potential upside, the risk/reward ratio might tilt very favorably towards these types of investments when something truly unique and valuable comes to the table. Reward-maximizers play here. The best ones, undoubtedly, are able to arbitrage perceived risk from actual risk.

Viewed from this lense, today’s idea flow from web start-ups constitutes a field day for Risk-minimizers. Most web ideas are focused on enabling new user experiences that don’t rely on major technology risks. The initial products can be developed for a few hundred thousand dollars. A passionate entrepreneur who seizes the opportunity first is equally as backable today as someone with a certain pedigree. That leaves market risk as the main ingredient to evaluate. Since products development costs are so manageable, some degree of market risk is usually alleviated before companies approach venture backers. Most web companies have some degree of customer traction before they take their first dollar of venture capital (not necessarily invested capital). That creates huge incentives to wait for investment opportunities which sort of speak for themselves because everything seems to be in place. This is the major force driving venture investment on the web today and sometimes clouds the possibility of investments with bigger upside possibilities. We’re living the venture equivalent of the inverted yield curve (for you former bankers, you know what I mean).

So what are the implications of today’s venture dynamics? Here where the sports parallels reach limitations. In baseball, it’s unlikely for a hitter in his prime to transition from one style to another. While it’s challenging in the venture business to do the same, it’s certainly not unheard of. The challenge stems from becoming proficient at investing with a certain success formula. The outlook and capabilities of a venture professional will be formed around successes. So when it comes to pattern recognition for new investments, those filters will be tuned specifically for what’s worked in the past. Based on the today’s funding tendencies, these are risk-minimized investments that have decent upside.

But venture investing is a knowledge business and it’s possible to tailor investment strategies for different phases of the technology industry. The mind is more versatile than physical mechanics (despite the link). Also, a break out investment made under the assumption of risk-minimizing can be the perfect way to learn the reward-maximizing kind of business. There are no steroids in the venture business that will turn a consistent doubles-hitter into a bonafide slugger, but serendipity is a better substitute. It’s the risk-adjusted way to learn how to spot the exceptions which make for homerun investments.

It’s important for an entrepreneur to align their start-ups with the investment approach of the venture professional. While there are venture folks who knows how to play things both ways, that’s the exception rather than the rule. If you have a company that offers an above-average risk profile (albeit compensated by a multiplier on reward), then you’re better off targeting investors who know how to make those investments. This will probably be a better use of time for both sides.

There’s no one way to make money in the start-up business as investor or entrepreneur. It’s good to match the know-how of a venture professional with the business opportunity being pursued by the entrepreneur.

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Tags: Barry Bonds, Web 2 0 Investments, Steroids, IRR, Risk and Reward, Inverted Yield Curve,