I just landed in Dubai from Helsinki, where I heard (and overheard) any number of pitches from startups attending the SLUSH event.¬†¬†What interested me most was overhearing the investors.¬† From their questions, it quite quickly would become¬†clear what type of investor they were - a government entity, an ex-entrepreneur, a unicorn hunter,¬†a financial investor...¬† and that got me thinking - how many investors really understand their motivation for investing?¬† How many¬†are honest with themselves about their mandate?¬† And how many *really* want to make money?
That might seem like a strange suggestion - that some venture investors might not want to make money.¬† But there are many reasons why investors might not want a financial return (fun/impact, ecosystem and¬†job creation, strategic industry creation) - and many co-responding¬†sources for capital that don't necessarily¬†come with an ROI attached.¬†¬†
Some investors invest for fun - truly, just for fun.¬† Sometimes they want to change the world, or give back,¬†even if in just a small way.¬† And sometimes they just want to play with new technology, or mix it up with new founders.¬†¬†
Sometimes, angels¬†run the numbers (like we have done at Hatcher+) - and come to the realization that focusing on the returns available in the form of¬†fun, jobs¬†and the satisfaction of curiosity¬†will generate positive returns several years ahead of the earliest financial returns - and they're fine with that.
Whatever your motivation is, I do think it's important to understand why you want to invest - and also, the limitations of your deal-sourcing model.¬†¬†
So let's start at the beginning.¬†¬†If you're investing for financial returns, rather than the non-financial reasons mentioned above,¬†it's important to realize how very hard it¬†is to make money out of investing in startups.¬† The ratio¬†of success to failure is¬†incredibly small - we know this, because we've looked at the data on¬†over 450,000 investments, and millions of business starts,¬†across 20 years.
The one constant we've found is that running a large portfolio is a critical factor in repeatable success.¬† Large portfolios don't tend to be amazing in terms of multiple generation, but they provide much more stable returns than small portfolios.¬†¬†¬†¬†¬†¬†¬†
If you're running a small portfolio, the odds are stacked against you.¬† Statistically, you have a 25% chance of succeeding.¬† ¬†And yes I know that [Union Square Ventures] has a number of small portfolios that¬†are generating¬†awesome ROIs, but that isn't the story for most small portfolios.¬† Most small portfolios fail - it's just a fact.¬† The few outstanding ones¬†that don't fail, plus solid¬†returns from the large portfolios maintained by the likes of NEA, Sequoia, Y Combinator, 500, etc, are the reason this asset class continues to outdo the NASDAQ (most years.)
What about "picking unicorns" as a strategy?¬† I hear this suggestion a lot from investors entering the VC space.¬† But¬†as I've presented on¬†at conferences several times in the past year, most¬†founders have¬†absolutely no idea they are creating a¬†transformative technology, or industry, while they are in the formative stages¬† - I'm talking about you Steve Chen (YouTube), Marty¬†Cooper¬†(the mobile phone), Darryl Zanuck (the television), Tom Watson (the computer.)¬†¬†
Tell me, if these, and¬†so many other¬†founder-investors didn't see their own revolution coming, how is it possible that you will?¬† That any of us will?
Picking unicorns is a crap strategy because almost¬†no one can do it at an early-enough stage for it to make sense as an investment strategy.¬†¬†Unicorns are incredibly elusive - appearing just once in roughly¬†200-250 funded companies (we've seen that¬†this¬†ratio varies quite a lot¬†by geography and portfolio quality, but this number will suffice¬†for this argument - plus,¬†the empirical evidence from¬†large startup portfolios managers¬†such as 500 Startups and Y Combinator supports this funding.)¬† The rare people able to pick unicorns did so on the basis of either large portfolios, or other large sample sizes (such as the very awesome¬†Eventbrite co-founder¬†Kevin Hartz, who, not only helped create Eventbrite, but¬†interviewed literally¬†hundreds of management teams in the Valley¬†while creating his portfolio¬†- which now includes several unicorns.)¬†¬†
If you want to make money from venture capital, you need a large portfolio - or you need to take a *lot* of meetings (a proxy for a large portfolio, essentially) - or¬†you need to be incredibly lucky.¬† The fact that you¬†need a¬†large portfolio to be reliably successful¬†is one of our¬†core findings, and the reason we're busy creating a one thousand company+ portfolio at Hatcher+ in partnership with our awesome co-investment network partners worldwide.¬†¬†