How do VC mitigate investment risk?
There are a number of slightly subtle things the best VCs do, and the rest really don’t:
- 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 Guy 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 Dogs for far more than they are worth. The best firms somehow sell their dogs 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.
- Minimizing 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. 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, really, really good at pricing. The best deals are always expensive, so this is hard. 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.
Published on April 20, 2016