Be an Entrepreneur: The Venture Outfits Need You

October 2, 2020

Institutional Investor ran an interesting story. No, that is not an oxymoron. Really. “The Pervasive, Head-Scratching, Risk-Exploding Problem With Venture Capital.”

I noted this passage:

Two-thirds of venture deals fail, researchers have found. With such a high mortality rate, a VC fund’s actual ending portfolio size is merely one-third of its invested companies’. So to arrive at an exposure with 20 to 70 companies, a fund needs a starting portfolio of 60 to 210 startup investments. Very few funds meet this size.

Without wrestling with the assumptions or the math, I thought this statement was fascinating:

Significant portions of the average come from very few outlier deals.

Now the assertion:

The golden rule for investors into the venture asset class must therefore be: Build a portfolio of 500 startups, with 100 companies being the absolute minimum.

Okay, how many venture firms do you know that have a portfolio of 500 start ups?

Then the question, “Why not buy a fund of VC funds?” Answer:

Based on industry studies, funds of funds frequently lack diversification across gender and race.

Nervous? Not to worry. Here’s why:

Is venture capital a risky asset class? No. Most VC funds choose to act in a risky manner by not diversifying, but that does not make the asset class risky. To de-risk venture capital, CIOs simply need to acknowledge that VC math is different from public markets math. The importance of low-probability, excess-return-generating investments means that proper diversification requires a portfolio of at least 500 startups.

But most VC firms don’t have 500 or more start ups in their portfolio? That’s what the write up said.

Does this seem to be reassuring?

Stephen E Arnold, October 2, 2020


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