In the history of the venture capital industry, I doubt there has ever been a catchier phrase to utter than "spray and pray" (for the uninitiated, this refers to the strategy of investing in a large number of early-stage companies - the "spray" component - in the hope that one or more of them might return the fund - the "pray" part.) It's catchy because it's alliterative (meaning, it rhymes) - and because it's a phrase that is used but rarely outside the venture industry, it has the added value of communicating that the user understands something deep and meaningful about that industry. Said with a scowl, a smile, or a shrug, it can be used to convey an entirely different take on the subject at hand (usually a fund, but sometimes an angel investor.)
Let's gets something out of the way right away: I am a fan of "spray and pray". Rather than a scowl, I am more likely to adopt a smile when I say it. Why? Because our research at Hatcher+ (see above), the research of independent third parties, and the increasingly publicly available results of large-scale managers, demonstrates that "spray and pray" is exactly what you should be doing if you're interested in embracing the odds, rather than trying to beat them. The strategy of building a large, diversified portfolio of venture investments is the one most likely to generate strong, predictable returns.
It's also what you should be doing if you're interested in creating a valuable pool of pro-rata rights. Or seeking to cherry-pick from a standardized, performance-based, ranked list of portfolio companies managed by a single manager. Or just looking, like us, to invest in the best crop of companies you can find, worldwide. (Note: I personally don't "pray" when I "spray" - you may disagree, but I view that part as optional, as it is unlikely to ever become part of our data-driven, systematic approach to managing companies.)
Now, not everyone is on board with creating large, massively diversified portfolios and robust, predictable returns. Some angel investors claim to practice the art of "unicorn hunting" - the process of investing in 1 out of every 10,000 business plans in the hope that it will turn into a billion dollar market valuation company. These artists claim to be able to spot them (the unicorns), while they are still in diapers. Before the first competitive analysis. Sometimes even before the first dollar of revenue. With a stated ability to pick 1 in 10,000, they may lay claim to be the ultimate odds-beaters.
Maybe for these folk, we should adopt the aphorism "Choose and Lose" - it's alliterative, snappy, it's going to be correct a lot of the time, and it's fun to say. What does the research say? The research suggests "choose and lose" is not a winning strategy, when compared to "spray and pray": Small, selective portfolios rarely beat large portfolios when it comes to generating predictable returns - and the majority of them don't beat the Nasdaq.
Except when they do. My accountant invested in a startup just once in his life. He put 40 grand into a startup business, got an 8x cash return within six months, and bought a wonderful red sports car. He chose and won. As do a small number of angel investors and micro VC fund managers who continue to crank out amazing returns from tiny numbers of companies, fund after fund.
What's happening here? Black swans? Sure. In a 1 in 10,000 world, someone is going to win 3 in 30,000 times. That's life. Unpredictable, and largely unfair - except for that guy with the sports car... :-)
For balance, I should add the obvious comment that not all "spray and pray" adherents make money. Some practitioners like to invest in 100% of what they see - something that anyone that has ever read a business plan would view as completely nonsensical (we prefer to adopt a selection ratio of 1%, and invest in around 1 in every 100 applications - for spray to work, you need good deal flow, a low selection ratio, and a disciplined approach to data analysis.) And some of the models that have been tried simply don't make sense (you know who you are.)
All of which goes to show that when it comes to snappy aphorisms like "spray and pray", or "choose and lose", catch-phrases are not really useful when it comes to describing or criticizing an investment strategy.
Better to avoid aphorisms all together and talk more concisely about whether you intend to embrace the odds... or how you intend to beat them.
[My thanks to my partner Dan Hoogterp for producing the above chart, which shows venture returns for various portfolio sizes vs. the IXIC (Nasdaq Composite) index - this provides a great illustration of why 67% of AUM targets larger venture portfolios.]
John is a serial entrepreneur and investor, and the Founding Partner of Hatcher+, a next-generation, data-driven venture firm that utilises a massive global database in combination with AI and machine learning-based technologies to identify early-stage opportunities in partnership with leading accelerators and investors worldwide.
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