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Over the years, I've thought a lot about VC and taking risk in VC. The VC game is a real mindwarp.
Some thoughts on taking risk when investing in startups:
Some thoughts on taking risk when investing in startups:
1) VCs are wrong most of the time. And that is ok!
VCs pick the "wrong" companies most of the time. In most professions, this would not be ok. If you are a brain surgeon, you cannot mess up 90% of the time. If you are a civil engineer, 90% of your buildings cannot fall apart.
VCs pick the "wrong" companies most of the time. In most professions, this would not be ok. If you are a brain surgeon, you cannot mess up 90% of the time. If you are a civil engineer, 90% of your buildings cannot fall apart.
2) When you are right, you must be really right.
In other professions, you hit a binary outcome w/ your work. The job was done right or wrong. As a result, in other professions, you cannot afford to mess up a lot since your outcome is capped. In VC, your upside is uncapped.
In other professions, you hit a binary outcome w/ your work. The job was done right or wrong. As a result, in other professions, you cannot afford to mess up a lot since your outcome is capped. In VC, your upside is uncapped.
3) So often, I come across angel investors who are from "capped industries". Like finance backgrounds (doing debt deals) or dentists or doctors. Ppl who maintain a "capped mentality" from their day jobs try to derisk startups as much as possible & hope for a 3x outcome.
4) But this is the opposite mentality of what you need to have to be successful. The best VCs have the mentality of, "the max I could lose is X but the gain is unlimited."
5) People have asked me if I think there are other models for VC - models where you get more winners and so they don't have to be as big to make up for all the losses. I think there's opportunity but I also think you can't run those funds in the same way as in VC.
6) All startups, no matter how big they can become, have the same initial risks - founder and market risks being the biggest in software. Taking the same high risk for less upside won't work.
7) In a new model like revenue based financing, what would work is taking less risk and better underwriting and better collections. If you can get into slightly "later" early stage companies & get more data than VCs can get AND get paid first, this can work. And do this in volume
8) I predict some of these new models will start to eat into the "post-seed / series A" stage. Not in entirety. But, a savvy founder would prefer to give up less equity once he/she realizes that something is starting to work.
9) There are currently 3 models of startup financing: equity, revenue-based financing, debt. (More here: elizabethyin.com/2019/07/19/how…) The key to success in each of these models is that you have to stay in your lane. E.g. you can't take high risk on companies with a low upside.
10) Unconventional players in startup financing are popping up & people don't realize it. Eg Brex - you think of them as a cc to buy stuff. But they are really debt financing & have more data than banks. They know what you spend money on. Banks just see the high level cash flows.
11) This is great for startups, because it means you have more competition on terms AND more choice in type of financing which affects dilution (e.g can take some debt or revenue-based financing instead of only equity investments).
