The math of portfolio size – why VC need not be so risky

In his Medium post, Matt H. Ler­ner, foun­der of Star­tup Core Strengths, con­si­ders the
calcu­la­tions behind risk and return in ven­tu­re capi­tal. Using a Mon­te Car­lo simu­la­tion, he
finds that cete­ris pari­bus, a lar­ger port­fo­lio yields mar­ked­ly bet­ter return mul­tiples than
smal­ler ones.

This is chiefly due to the power law cha­rac­te­rizing VC returns, which implies that a small
num­ber of port­fo­lio com­pa­nies bring in a lar­ge por­tion of total returns. Simply put, the
more com­pa­nies you have, the more like­ly it is that you find an out­lier that ends up
beco­ming a unicorn and yields a gar­gan­tuan multiple.

Of cour­se, VCs do not choo­se their firms ran­dom­ly, and some of the top ones high­ly
bene­fit from their brand and con­nec­tions which cer­tain­ly boost the pro­ba­bi­li­ty of success
for all of their res­pec­ti­ve port­fo­lio com­pa­nies. The abo­ve still holds true, and we at Goril­la
Capi­tal have since 2012 been vocal advoca­tes of the lar­ge port­fo­lio approach.

The diver­si­fica­tion bene­fits from having 70+ acti­ve com­pa­nies in total in our Funds I & II
mean that our success is actual­ly not even con­tin­gent on fin­ding the occa­sio­nal unicorn.
Ins­tead, the bulk of the solid returns is gene­ra­ted from a lar­ge num­ber of success­ful,
ear­lier-sta­ge exits. Howe­ver, should a port­fo­lio com­pa­ny show poten­tial to reach a bil­lio­neu­ro IPO, we cer­tain­ly sup­port them on their path – our approach doesn’t force any
arti­ficial cei­ling on companies.

The­re are some unders­tan­dable rea­sons behind LPs pre­fer­ring mana­gers that prac­tice
unicorn-hun­ting over this more sen­sible stra­te­gy. First, ven­tu­re capi­tal is seen as an asset
class with a high level of risk cor­re­la­ted with a high level of reward. LPs might feel as
though they can get solid returns with a soun­der risk level from other assets. Second, the
irra­tio­nal opti­mism cha­rac­te­rizing the enti­re ven­tu­re capi­tal industry is strongly pre­sent
when funds are pitc­hing to LPs: the dra­ma­tic, emo­tio­nal and ove­rop­ti­mis­tic sty­le often
entices more than a more cynical one.

At Goril­la, our mis­sion is thus to show that a lar­ger port­fo­lio size of com­pa­nies is also able
to gene­ra­te sizeable returns for inves­tors. We are essen­tial­ly hed­ging our down­si­de
wit­hout limi­ting our upsi­de in the sligh­test. The success of our pre­vious funds applying
this stra­te­gy ser­ves as empi­rical proof: the gene­ral VC wis­dom of unicorn-hun­ting can and
should be challenged.

A Tale of Two Squir­rels: The Not So Simple Math on Ven­tu­re Port­fo­lio Size:

Getting Funding is NOT a Strategy

Money is always a con­sequence, not the root cause. You work – you get paid. You sell – cus­to­mer pays. You roll the dice and get luc­ky – you get rich. You have a busi­ness (plan) that works – you get funding.

But get­ting fun­ding is not the end goal, not even for a star­tup. The end goal is to be able to pay all that fun­ding back, and some more. To reach that you need to have a busi­ness that works. For get­ting the­re, you need the right stra­te­gy. The stra­te­gy should be all about your busi­ness: who is your cus­to­mer, what is your offe­ring, how you plan to win etc. 

The jour­ney from whe­re you are today to whe­re you need to be one day is typical­ly so long that you may need to top up some fuel on the way. Fun­ding is your fuel, hel­ping you to get whe­re you need to go. But it’s just a means to an end, not the rea­son your star­tup exists and defi­ni­te­ly not your Nort­hern Star. It should not be the dri­ver for your thin­king and acti­vi­ties, do not let  “what do I need to do to get fun­ded” to mis­lead you. 

Are you the only VC type investor who has such a strategy?

No, but this is still more of an “excep­tion” rat­her than “the norm”. Some inves­tors who have a simi­lar kind of basic phi­lo­sop­hy (model is more of a “sca­lable Angel” rat­her than “VC”) (the only Euro­pean on this list) (we owe a lot to the­se guys for set­ting up a role model we have taken full advan­ta­ge of. Big thanks to Kevin & al for the ins­pi­ra­tion and open­ly sha­ring their thin­king) (buil­ding on the heri­ta­ge of the ori­gi­nal Supe­rAn­gel Ron Conway, they have the lon­gest track record to demon­stra­te the stra­te­gy works) (the most vocal on this list. For them inves­ting is just one of the things they do)
The­re cer­tain­ly are more but most inves­tors with this stra­te­gy tend to pre­fer a low public pro­fi­le, they focus on their busi­ness rat­her than PR.

What do you mean with Startup/Investor fit ?

Simi­lar to product/market fit, the­re needs to be a match between what the star­tup needs and the inves­tor can offer. This applies first to all “visible” ele­ments of the investor’s scree­ning pro­fi­le: fit against invest­ment stra­te­gy, sta­ge, tic­ket size, ver­tical focus etc vs the pro­fi­le of the star­tup. And it goes bey­ond the “visible” – the­re needs to be a strong align­ment in values, phi­lo­sop­hies, ways of wor­king etc for the rela­tions­hip to last during the rough ride ahead. We are not the right inves­tor for many, as what we belie­ve in is rat­her dif­fe­rent from the ste­reo­ty­pical thinking. 

How do you differ from other VCs ?

Eve­ry inves­tor should have a clear invest­ment stra­te­gy, inclu­ding an exit the­sis. What we belie­ve in is what pro­fes­sio­nal Angel inves­tors in the US have prac­ticed for years and pro­ven to work. Which results in a very dif­fe­rent approach from the typical VC. So whi­le we tech­nical­ly are a VC (=we make a living of inves­ting 3rd par­ty funds in star­tups), our phi­lo­sop­hy is much clo­ser to that of an Angel inves­tor (who invest their own money, so the down­si­de risk feels more real). 

Will you help us get other investors?

Not real­ly, we deci­de for our­sel­ves only and expect the foun­ders to reach out to other inves­tors. It is also an acid test of the founder’s abi­li­ty to sell – if you can­not sell your­self and your busi­ness to inves­tors, you are like­ly to fail with cus­to­mers as well. 

What else besides your “OK” is needed to close the investment with payment?

Gover­nance and Legal DD (Due Dili­gence) and Agree­ments. We have stan­dar­di­sed proces­ses and templa­tes on both, the­re are no man­da­to­ry out of poc­ket expen­ses. The speed of the process is in your hands as you will do most of the work. We do not insist on our proces­ses if the­re are bet­ter alter­na­ti­ves. We care about the end result, and are prag­ma­tic about get­ting the­re. But we do need a pro­per DD and Agreements. 

How long does your investment decision take ?

For us making the ”yes we’re in” deci­sion is fast – can hap­pen in days. Deci­sion is made among the 3 of us, no com­mit­tees nee­ded. We work inde­pen­dent­ly and our deci­sion does not depend on what others do so we are often the first to com­mit.
But get­ting to the clo­sing inclu­ding pay­ment total­ly depends on you. If you are well pre­pa­red and execu­te prompt­ly on all for­ma­li­ties it can go through in a few weeks, but usual­ly it takes lon­ger – can be seve­ral months. Two most com­mon rea­sons for that are:

  1. You do not have enough inves­tors to clo­se the round (we are never the only inves­tor so you will need others)
  2. The DD brings up issues that need to be addres­sed prior to final clo­sing (such as unfi­nis­hed paperwork in sha­re transfers).

What kind of companies will you invest in?

Plea­se read

  1. The invest­ment cri­te­ria lis­ted on our website
  2. Goril­la” rela­ted articles on Knowledgebase
  3. What Foun­ders Say about Us” testimonials

Tho­se 3 should give you a fair­ly good unders­tan­ding of what we are like and what we are loo­king for.

Gorilla Capital Management Oy

VAT 2827907-4

Maria 01, Building 1, entrance B
Lapinlahdenkatu 16, 00180 Helsinki


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