Happy Thanksgiving!
Love this perspective on fund diversity and deployment strategy.
"For early stage investing, large portfolios (~100 investments) outperform small portfolios (~30 investments).
The goal for pre-seed or seed GPs is to invest in a large enough number of companies to maximise the chance of finding outliers (about 2% for ~50x, 5% for ~15x according to data from Dave McClure).
From that point, once you have built a sufficiently diversified portfolio, you can consider a strategy to deploy remaining funds into follow-on rounds for best looking companies as "call options".
This only makes sense if you think these follow-ons are the best opportunity available for that capital. Evaluate them as you would any other investment.
A lot of VCs (and LPs, for that matter) understand the logic of concentrating into winners, but not the first step of building an appropriately sized portfolio.
Why? Probably because the former amplifies risk, while the latter reduces it — playing into the principal-agent problem in VC and the "power law" smokescreen. It also happens to be a lot easier to manage a small portfolio.
I've spoken to LPs that say they prefer small portfolio strategies because concentrating into winners is more likely to produce >10x returns. In a world where only the top 5% return >3x, it makes ZERO sense to optimise for that level of risk. Especially when you are allocating other people's capital (pension funds, MFOs, sovereigns, etc).
"Few investors demand diversified funds, so GPs don’t offer them. A slow and steady 'venture is a numbers game' pitch is much less emotionally compelling than 'I am a rock star who can consistently beat the odds.' And GPs need an emotionally appealing pitch to get funded."
- The Pervasive, Head-Scratching, Risk-Exploding Problem With Venture Capital"
This is how we built our fund's strategy -- to invest early in a diverse portfolio. Our current partially deployed fund already has 42 bets, averaging a deal every 1.8 weeks.
Dave McClure taught us that investing in 50 companies on a 10x lower cost basis leads to close to the same ownership in each one as investing the same capital in just 5 companies.
This approach seems advantageous for startups too as it allows us to give an easier yes to diverse and early companies. We are still finding our sweet spot around valuations and portfolio construction, and we are passionate about these core principles.
Jamie Rhode, CFA has done many podcasts on this for those who want to hear more about the data.
I look forward to fund 2 when we will have enough capital to both make diverse bets (60+) as well as have follow-on capacity for winners when they are, as Dan says, the best available opportunity for that capital.
For investors and startups, what do you think about this strategy?
https://lnkd.in/gizefUYC
Benjamin Rolnik Julia C. Manu Satyavolu Aman Verjee, CFA Sophia Platt
