Should VCs be more open to the spray & pray approach?
One of my favorite debates resurfaced again this week at the RAISE conference here in SF.
In one corner: LPs and GPs who believe in concentrated bets in few companies with significant follow-on capital.
In the other: GPs (and fewer LPs) who believe in more diversified bets into very early companies with more ownership upfront and less follow-on capital.
Look, I get it. Many LPs believe that the core value of the VC is the picking - so if your portfolio is 2-3x bigger than most seed-stage VCs, it signals you don't know what you're looking for.
Of course a counter point may be that if you take more swings, each individual bet can be less consensus. Easier to back the wildest ideas if the fund has 50 portcos vs 25.
Let's look at some (๐๐ถ๐บ๐๐น๐ฎ๐๐ฒ๐ฑ) data. Chart below is from Dan Gray at Equidam who everyone should go follow.
It looks at two portfolio strategies available to a VC manager with a $50 million fund (so $40M of investable capital).
Conviction = 20 portfolio companies at $2M each
Diversified / "Spray and Pray" = 100 portfolio companies at $0.4M each
After many assumptions, the diversified portfolio beats the concentrated one for MOIC (Multiple on Invested Capital) at every point along the curve except for the stellar funds.
Said differently - if you are a top 5% fund, concentration wins. If youโre not, diversification wins.
๐ง๐ต๐ฒ ๐ณ๐๐น๐น ๐ฏ๐ฟ๐ฒ๐ฎ๐ธ๐ฑ๐ผ๐๐ป:
๐ ๐ฒ๐ฎ๐ป ๐ณ๐๐ป๐ฑ ๐บ๐๐น๐๐ถ๐ฝ๐น๐ฒ: Diversified: 2.6xย | Concentrated: 2.1x
๐ ๐ฒ๐ฑ๐ถ๐ฎ๐ป ๐ณ๐๐ป๐ฑ ๐บ๐๐น๐๐ถ๐ฝ๐น๐ฒ: Diversified: 2.5โฏxย | Concentrated: 1.9โฏx
๐๐ต๐ฎ๐ป๐ฐ๐ฒ ๐ผ๐ณ > ๐ญ๐ (๐ฐ๐ฎ๐ฝ๐ถ๐๐ฎ๐น-๐ฝ๐ฟ๐ฒ๐๐ฒ๐ฟ๐๐ถ๐ป๐ด): Diversified: โโฏ99.7โฏ% | Concentrated: 81.9โฏ%
๐๐ต๐ฎ๐ป๐ฐ๐ฒ ๐ผ๐ณ ๐ฎ๐ : Diversified: 77โฏ% | Concentrated: 47โฏ%
๐๐ต๐ฎ๐ป๐ฐ๐ฒ ๐ผ๐ณ ๐ฏ๐ : Diversified: 27โฏ% | Concentrated: 22โฏ%
๐ง๐ผ๐ฝ ๐ฑ% ๐ผ๐๐๐ฐ๐ผ๐บ๐ฒ: Diversified: 4.0x | Concentrated: 4.8โฏx
Now look, there are tons of other factors to consider. Things like ability to follow-on into your winners, time available to support each portfolio founder, etc.
๐ ๐ ๐ฐ๐๐ฟ๐ฟ๐ฒ๐ป๐ ๐๐ถ๐ฒ๐:
If you're a seed fund that sees 2,000 companies per year, investigates 300, and invests in 15...you'd ๐ฝ๐ฟ๐ผ๐ฏ๐ฎ๐ฏ๐น๐ ๐ฏ๐ฒ ๐ฏ๐ฒ๐๐๐ฒ๐ฟ ๐ผ๐ณ๐ณ ๐ถ๐ป๐๐ฒ๐๐๐ถ๐ป๐ด ๐ถ๐ป ๐ฎ๐ฌ ๐ถ๐ป๐๐๐ฒ๐ฎ๐ฑ, with slightly bigger checks upfront and less reserves.
Come hang out (virtually) on 10/29 at 10am PT and chat about fund construction and performance with me: https://lnkd.in/geibU_Bn
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