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Three Core Principles of Venture Capital Portfolio Strategy


Wow, what a detailed article! We know that VC is a home-run business, but we see here a lot of "nerdy" numbers with some more insights on the accelerators and how their portfolio strategy fit with VC's and the importance of follow-ons. Worth remembering that during a recent Kauffman meeting an important LP mentioned that the EU VCs underperformance vs. US's is generally explained by too much diversification.


Mapping Where Europe’s Population Is Moving, Aging, and Finding Work @lmvpUK

  • Growth in startups worldwide has seen an influx of new professionals into venture capital. $3.8bn across 32 first-time manager funds was raised in 2016, continuing the trend over the last 5-7 years.
  • Returns for the asset class as a whole continue to be lackluster. VC returns haven’t significantly outperformed the public market since the late 1990s, and, since 1997, less cash has been returned to investors than has been invested into VC.
  • A driver of these returns is the decreasing barrier to entry for the industry and the basic mistakes made by many new entrants.
  • VC is a game of home runs, not averages. Strikeouts are extremely common. 65% of venture deals return less than the capital invested in them. But strikeouts don’t matter. The best performing funds actually have more strikeouts than mediocre funds.
  • The vast majority of a venture fund’s returns come from a few home run investments. For the best performing funds, less than 20% of their deals generate 90% of the returns.
  • Not only do the best funds have more home runs, they have bigger, better home runs.
  • Home runs are also extremely rare; the chances of hitting one are in the 0.5-2% range.
  • Some funds (e.g., 500 Startups) have gone for a strategy of maximizing at-bats. However, larger portfolios come at the detriment of quality. The ratio of accelerator-funded startups receiving follow-on investments is 18%, significantly below the market average of c. 50%.
  • Top US VC funds tend to do 1-20 investments per year, with the larger funds focused on the lower end of this range. Within a 4-5 year investment period, this implies a portfolio size of less than 50. Conventional wisdom in the VC space seems to be for there to be 20-40 companies in a given portfolio.
  • Many newcomers to the space fail to reserve sufficient capital to follow-on in the companies they have invested in. Andreessen Horowitz’ 2010 investment in Instagram of $250k, for instance, returned 312x in less than two years. Whilst being an incredible return on a deal basis, at a fund level Andreessen would have had to invest in 19 other companies on the same terms and with the same incredible performance to break even on the fund as a whole, illustrating the importance of following-on in the home run investments in a portfolio.

Read more here: https://www.toptal.com/finance/venture-capital-consultants/venture-capital-portfolio-strategy

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