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:

Camels vs Unicorns

In his article for Soa­ked by Slush, Chris­tian Owens, co-foun­der and CEO of the sca­leup
Padd­le rai­ses the concern that the met­rics cur­rent­ly used to quan­ti­fy Euro­pean tech
success are due for a chan­ge. The ove­remp­ha­sis on unicorns leads to a tun­nel vision in
which only the gigan­tic exits are valued, and the nume­rous smal­ler ones neglec­ted.
The aut­hor argues that the ove­rall health of the Euro­pean star­tup eco­sys­tem rests on the
hundreds and thousands of small busi­nes­ses beco­ming success­ful and sca­ling up only
when solid foun­da­tions are built, ins­tead of see­king aggres­si­ve growth via big fun­ding

Our team at Goril­la Capi­tal ful­ly endor­ses this view. In our opi­nion, start-ups often try to
jump the growth cur­ve, and end up trying to sca­le a pro­duct which hasn’t yet had time to
morph into its final ver­sion. This beha­viour is often due to the phe­no­me­non men­tio­ned
abo­ve. If a bil­lion-euro valua­tion is seen as the holy grail, many com­pa­nies adopt a
mind­set of aggres­si­ve ear­ly-sta­ge growth wit­hout taking the time to pon­der whet­her their
pro­duct is rea­dy to be scaled.

That is why we actual­ly seek “camels” ins­tead of unicorns. The­se are the com­pa­nies that
are capi­tal efficient, have solid unit eco­no­mics, and focus on buil­ding sus­tai­nable growth.
Admit­ted­ly, the ini­tial growth rate may be slower than that of an aspi­ring unicorn, but the­se
com­pa­nies are more robust and resi­lient than their peers.

In good times, the camels thri­ve, but even under uncer­tain­ty, they sur­vi­ve, unli­ke the
aspi­ring unicorns that jum­ped the growth cur­ve with high valua­tions and wind up with
downs rounds when the ove­rall eco­no­mic cli­ma­te wor­sens and the bubble bursts.

Stop tal­king about unicorns: The way we mea­su­re Euro­pean tech success needs to

Stop tal­king about unicorns: The way we mea­su­re Euro­pean tech success needs to

Sustainable Finance Disclosure

Kos­ka Goril­la Capi­tal Fund 2017 Ky:n sijoi­tus­koh­teet ovat nuo­ria ja juu­ri perus­tet­tu­ja yri­tyk­siä, tähän rahoi­tus­tuot­tee­seen sisäl­ty­vis­sä sijoi­tuk­sis­sa ei ote­ta huo­mioon ympä­ris­tön kan­nal­ta kes­tä­viä talou­del­li­sia toi­min­to­ja kos­ke­via EU:n kriteerejä

The Corona issue – what to think about it ?

Fri­day Mach 6, 2020

To: Goril­la Capi­tal port­fo­lio companies

From: Ris­to Rautakorpi

The Coro­na issue – what to think about it

Note – I focus enti­re­ly on the busi­ness implica­tions, per­so­nal health & safe­ty is of cour­se #1 prio­ri­ty and I lea­ve tho­se mat­ters for the Healthca­re pro­fes­sio­nals to advi­se on.

I rat­her cry wolf than regret later, and as “only the Para­noid sur­vi­ves”, I’m OK to be the paranoid.

No-one knows yet what the end outco­me of the Coro­na issue will be. But alrea­dy now it has caused a visible dis­tur­bance on busi­nes­ses and eco­no­mies worldwi­de and the ripple effects are yet to be seen. Some busi­nes­ses are affec­ted more than others, but very few will be comple­te­ly immu­ne. For some (like face mask pro­ducers or remo­te wor­king solu­tions) this can crea­te a mas­si­ve windfall.

Your busi­ness will be affec­ted as well. In what way, when and how seve­re­ly, depends. That’s what you should now form a view on, and do miti­ga­tion accordingly.

A like­ly sce­na­rio for any­one sel­ling to cor­po­ra­tions: In the 1st wave, they focus on their people risks: they cancel atten­ding events, making busi­ness trips, they ask people to work from home etc. In the 2nd wave they do the imme­dia­te adjust­ments to their own busi­ness (such as air­li­ne industry), in the 3rd wave they start calcu­la­ting the cost of all that, and how to balance the effect. They will try to assess what their cus­to­mers do and how that will affect their own busi­ness. The 1st thing they’ll do is step on the bra­kes and will do only the man­da­to­ry until the dust has sett­led – which means anyt­hing non-man­da­to­ry will be post­po­ned. They will try to mana­ge costs, in antici­pa­tion of their reve­nues decli­ning. This may mean lay­offs, freezing any new costs (such as deve­lop­ment pro­jects) etc. They will have to add new issues on their agen­da, chan­ging the prio­ri­ties. At this point you will start fee­ling the heat.

The­se “never seen befo­re” cri­sis are part of the busi­ness cycles. I’m older than any of you so I have expe­rienced a few (and their direct con­sequences) myself: oil cri­sis 1973, Cher­no­byl 1986 (this was par­ticu­lar­ly sca­ry in Fin­land, due to the typical wind direc­tions), Iraqi war and 2nd oil cri­sis 1990, dot com crash 2000, Financial cri­sis 2008. Not to men­tion the next tier – SARS, Thai­land Tsu­na­mi etc.

It’s not a bug, it’s a fea­tu­re. If you sail across the Atlan­tic you’re like­ly to get into at least one big storm. You know that from the start so you pre­pa­re accor­dingly. And when the weat­her map turns dark, you get rea­dy: you take down sails, clo­se all holes, tie eve­ryt­hing down, eat and rest whi­le you still can, make rain­gear rea­di­ly avai­lable. When the storm hits you, you are pre­pa­red. Then you do what you must to stay afloat, and just wait. Even the worst storms end one day, the sun is shi­ning again and smooth sai­ling can continue. 

But whi­le sai­ling after is no dif­fe­rent from sai­ling befo­re, busi­ness after a cri­sis is never qui­te the same as befo­re. Oil cri­sis trig­ge­red the need to reduce depen­dency on oil, Financial Cri­sis tigh­te­ned regu­la­tion of financial mar­kets etc. The man­kind is trying take mea­su­res that “this could never hap­pen again” (rat­her success­ful­ly, as the next major cri­sis is always a “never seen befo­re” kind). Tho­se chan­ges crea­te a ton of new busi­ness opportunities. 

The Coro­na situa­tion – once over and back to nor­mal - will trig­ger such chan­ges as well. What exact­ly, we all can make educa­ted gues­ses about. They too will crea­te opportunities.

Pro­fits are made during the high sea­son. Stra­te­gic moves are made during the low season. 

My call to action to all of you:

  1. The even­tual con­sequences of Coro­na will affect all of you (and us, as a result). Mea­ning you all need to take it on your agenda.
  2. You should ana­ly­se your situa­tion (and that of your key cus­to­mers), play with some sce­na­rios and form a view on what you assu­me the implica­tions to your busi­ness to be
  3. What is it you can and should do to miti­ga­te the nega­ti­ve effects. Crea­te an action plan on what to do if the storm hits you, and what is the indica­tor tel­ling you the storm is on
  4. What new oppor­tu­ni­ties will this crea­te, once the storm is over. How could you best bene­fit of it?

I since­re­ly hope none of this is ulti­ma­te­ly nee­ded and the world goes back to nor­mal soon. But it would be irres­pon­sible to just count on being luc­ky. Hope for the best, pre­pa­re for the worst!


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. 

When is the best time to do the exit?

When the buyer is wil­ling to buy you at rea­so­nable terms. The most cri­tical ele­ment of this is the moti­va­tion of the buyer, and that is out of your cont­rol. The “open to buy” win­dow is crea­ted when their stra­te­gy shows a need they need to address and do it your­self doesn’t real­ly cut it. That’s when they start loo­king, and you need to make sure you show in their radar screen when they do. And that is the part which you CAN cont­rol. Some­ti­mes this hap­pens ear­lier than you would have liked, some­ti­mes later. Timing is not in your hands. Accept it, and act accordingly. 

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.

Gorilla Capital Management Oy

VAT 2827907-4

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


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