Q: How Do VCs Mitigate Investment Risks?

For a while in the peak craziness of late 2020-early 2022, VCs in many cases … stopped mitigating risk.  The upside seemed just so high when public SaaS companies were trading as high as 50x ARR or sometimes more.

But now we’re back.  To every VC taking risk, yes, that’s the job.  But also mitigating it where practical.

There are a number of slightly subtle things the best VCs do, and the rest often don’t, to mitigate risk:

  • Getting other investors to carry their “Yellow Lights”.  You’ll end up with investments sort of doing OK, with customers, but really burning too much cash to justify another check.  The best VCs find Another VC to put in 90% of the Next Check here.  You don’t have to write off the investment, but you don’t have to throw much more questionable money into the deal, either.
  • Selling their underperformers for more than they are worth.  The best firms somehow sell their worst deals for $0.50 on the dollar, or $1 on the dollar, or even $1.50 on the dollar … when, really, they are write-offs.  This helps a lot.  I don’t know how they do it.  But they do.  They get acquirers to buy startups that others can’t engineer.
  • Minimizing fund politics.  Politics can wreck returns.  Yes, every partner needs to deploy $X per fund.  But returns are rarely consistent across partners.  By making sure investment decisions are as free of politics as possible, fewer “Almost” deals get done, and fewer second and third checks are wasted on the wrong portfolio companies.  The Almost deals never return much, if any, capital.  Partners with little deal flow, or poor deal flow, or fewer relationships, should be doing fewer deals, or playing other roles.
  • Building the right syndicates for capital-intensive deals.  The wrong syndicate can wreck a capital-intensive start-up.  No one wants to write the next check until there is a lead and FOMO.  Lack of support in the syndicate, or a tapped-out syndicate, dramatically impacts growth and returns.
  • Getting really good at pricing.  This is different than low-balling founders and deals.  The best deals are always expensive, so this is hard.  Even more so today, in the Best of Times in SaaS and Cloud.  So it’s not as simple as being “disciplined” on price.  Then you would have missed Slack at $250m.  Or passed on Facebook’s Series B — Peter Thiel’s #1 investing regret.  It’s especially important at medium and later stages, and there are many ways to do this.  You can take a little more stage risk.  You can build an epic brand.  You can be an amazing partner to the VCs in the round before.  You can pass when you can’t make enough money on a great one.  It’s nuanced.  But the best firms are really, really good at this.
  • Moving on with their time.  Top VCs will often support the best founders even through tougher times.  But mediocre founders?  Or founders not giving it 100%?  You sort of need to step off the board and step out of engagement if possible.

A related post here:

Need a Second Check From Your VCs? Here’s How “Reserves” Work

(note: an updated SaaStr Classic answer)

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