The espresso shot:
- What are the essential elements of a “good” VC fund strategy vs. “lucky”?
- What elements can you control and what can you not?
- How long does it take to develop “skill” and can you speed it up w/ (intentional) practice?
Anyone can shoot a three-pointer every once in a while.
Steph Curry is undeniably one of the best shooters of our time. If not, of all time. Even if you don’t watch ball, one can’t help but appreciate what a marksman Steph is. In case you haven’t, just look at the clip below of his shots during the 2024 Olympics.
As the Under Armour commercial with Michael Phelps once put it, “it’s what you do in the dark that puts you in the light.” For Steph, it’s the metaphoric 10,000 hours taking, making, and missing shots. For the uninitiated, what might be most fascinating is that not all shots are created equal, specifically… not all misses are created equal.
There was a piece back in 2021 by Mark Medina where he wrote, “If the ball failed to drop through the middle of the rim, Curry and Payne simply counted that attempt as a missed shot.” Even if he missed, the difference between missing by a wide margin versus hitting the rim mattered. The difference between hitting the front of the rim versus the backboard or the back rim mattered. The former meant you were more likely to make the shot after the a bounce than the other. Not all misses are created equal.
Anyone can shoot a 3-pointer. With enough tries. But not everyone can shoot them as consistently as Steph can.
The same holds for investing. Many people, by sheer luck, can find themselves invested in a unicorn. But not everyone can do it repeatedly across vintages. It’s the difference between a single outperforming fund and an enduring firm.
The former isn’t bad. Quite good actually. But it also takes awareness and discipline to know that it may be a once-in-a-lifetime thing. The latter takes work. Lots of it. And the ability to compound excellence.
When one is off, how much are you off? What are the variables that led you to miss? What variables are within your control? And what aren’t? Of those that are, how consistent can you maintain control over those variables?
As such, let me break down a few things that you can control as a GP.
Deal Flow
Are you seeing enough deals? Are you seeing enough GREAT deals? Do you find yourself struggling in certain quarters to find great deals or do you find yourself struggling to choose among the surplus of amazing deals that are already in your inbox? Simply, are you struggling against starvation or indigestion? It’s important to be intellectually honest here, at least to yourself. I know there’s the game of smokes and mirrors that GPs play with LPs when fundraising, but as the Richard Feynman line goes, “The first principle is that you must not fool yourself—and you are the easiest person to fool.”
Value Add
Whereas deal flow is about what companies you see, value add is more about how you win deals. Why and how do you attract the world’s best entrepreneurs to work with you? In a world where the job of a VC is to sell money – in other words, is my dollar greener or is another VC’s dollar greener – you need to answer a simple question: Why does another VC fund need to exist?
What can you provide a founder that no other, or at least, very few other, investors can
While there are many investors out there who say “founders just like me” or “founders share their most vulnerable moments with me”, it’s extremely hard for an LP to underwrite. And what an LP cannot grasp their head around means you’ll disappear into obscurity. The file that sits in the back of the cabinet. You’ll exist, and an LP may even like you, but never enough for them to get to conviction. And to a founder, especially when they’ve previously “made it”, already, you will fall into obsolescence because your value-add will be a commodity at scale. Note the term “at scale.” Yes, you’ll still be able to win deals on personality with your immediate network, and opportunistically with founders that you occasionally click with. But can you do it for the three best deals that come to your desk every quarter for at least the next four years? If you’re building an institutional firm, for the next 20+ years. Even harder to do, when you’re considering thousands of firms are coming out of the woodwork every year. Also, an institutional LP sees at least a few hundred per year.
For starters, I recommend checking out Dave’s piece on what it means to help a company and how it impacts your brand and perception.
Portfolio Size
Deal flow is all about is your aperture wide enough. Are you capturing enough light? Portfolio size is all about how grainy the footage is. With the resolution you opt for, are you capturing enough of the details that could produce a high definition portfolio? In venture, a portfolio of five is on the smaller side. And unless you’re a proven picker, and are able to help your companies meaningfully or you’re in private equity, as a Fund I, you might want to consider a larger portfolio. It’s not uncommon to see portfolios at 30-40 in Fund I that scale down in subsequent funds once the GPs are able to recognize good from great from amazing.
I will also note, with too big of a portfolio, you end up under optimizing returns. As Jay Rongjie Wang once said, ““The reason why we diversify is to improve return per unit of risk taken.” At the same time, “bear in mind, every fund that you add to your portfolio, you’re reducing your upside as well. And that is something a lot of people don’t keep in mind.”
Moonfire Ventures did a study in 2023 and found that “the probability of returning less than 1x the fund decreases as the size of your portfolio grows, and gets close to zero when your portfolio exceeds 200 companies.” That said, “it’s almost impossible to 10x a fund with more than 110 companies in your portfolio.”
While there’s no one right answer in the never-ending diversified versus concentrated debate, nevertheless, it’s worth doing the work on how size and the number of winners in your portfolio impact returns.
Valuations and marks
First off, how are you measuring your marks? Marc Andreessen explains the concept of marks far better than I can. So not to do the point injustice, I’m just going to link his piece here.
Separately, the earliest proxies of portfolio success happens to revolve around valuations and markups, but to make it more granular, “valuation” really comes down to two things:
- Graduation rates
- Pro rata / follow-on investments
Graduation rates
When your graduation rates between stages fall below 30%, do you know why? What kinds of founders in your portfolio fail to raise their following round? What kinds of founders graduate to the next stage but not the one after that? Are you deeply familiar with the top reasons founders in your portfolio close up shop or are unable to raise their next round? What are the greatest hesitations downstream investors have when they say no? Is it the same between the seed to Series A and the A to B?
Pro rata / follow-on investments
Of your greatest winners, are you owning enough that an exit here will be deeply meaningful for your portfolio returns. As downstream investors come in, naturally dilution occurs. But owning 5% of a unicorn on exit is 5X better than owning 1% of a unicorn. For a $10M fund, it’s the difference for a single investment 1X-ing your fund and 5X-ing it.
When you lose out on your follow-on investment opportunities, what are the most common reasons you didn’t capitalize? Capital constraints? Conviction or said uglier, buyer’s remorse? Overemphasis on metrics? Lack of information rights?
Then when your winners become more obvious in the late stages and pre-IPO stages, it’s helpful to revisit some of these earlier decisions to help you course-correct in the future.
I will note with the current market, not only are the deal sizes larger (i.e. single round unicorns, in other words, a unicorn is minted after just one round of financing), there are also more opportunities to exit the portfolio than ever before. While M&A is restricted by antitrust laws, and IPOs are limited by overall investor sentiment, there have been a lot of secondary options for early stage investors as well. But that’s likely a blogpost for another day.
In closing
To sum it all up… when you miss, how far do you miss?
Obviously, it’s impossible to control all the variables. You cannot control market dynamics. As Lord Toranaga says in the show Shogun when asked “How does it feel to shape the wind to your will?”, he says “I don’t control the wind. I only study it.” You can’t control the wind, but you can choose which sails to raise, when you raise them, and which direction they point to. Similarly, you also can’t completely control which portfolio companies hit their milestones and raise follow-on capital. For that matter, you also can’t control cofounder splits, founders losing motivation, companies running out of runway, lawsuits from competitors, and so on.
But there are a select few things that you can control and that will change the destiny of your fund. To extend the basketball analogy from the beginning a bit further, you can’t change how tall you are. But you can improve your shooting. You can choose to be a shooter or a passer. You can choose the types of shots you take — 3-pointers, mid-range, and/or dunks. In the venture world, it’s the same.
The choice. Or, things you can change easily:
- Industry vertical
- Stage
- Valuation
- Portfolio size
- Check size
- Follow-on investments
The drills. Or, things you can improve with practice:
- Deal flow – both quantity and quality
- The kinds of deals you pick
- Value add – Does your value-add improve over time? As you grow your network? As you have more shots on goal?
- The deals you win – Can you convey your value-add efficiently?
And then, the game itself. The things that are much harder to influence:
- Graduation rates
- Downstream dilution
- Exit outcomes
- The market and black swan events themselves
Venture is a game where the feedback cycles are long. To get better at a game, you need reps. And you need fast feedback loops. It’s foolhardy to wait till fund term and DPI to then evaluate your skill. It’s for that reason many investors fail. They fail slowly. While not as fast of a feedback loop as basketball and sports, where success is measured in minutes, if not seconds – where the small details matter – you don’t have to wait a decade to realize if you’re good at the game or not in venture. You have years. Two to three What kinds of companies resonate with the market? What kinds of founders and companies hit $10M ARR? In addition, what are the most common areas that founders need help with? And what kinds of companies are interesting to follow-on capital?
Do note there will always be outliers. StepStone recently came out with a report. Less than 50% of top quartile funds at Year 5 stay there by Year 10. And only 3.7% of bottom-quartile funds make it to the top over a decade. Early success is not always indicative of long-term success. But as a VC, even though we make bets on outliers, as a fund manager, do not bet that you will be the outlier. Stay consistent, especially if you’re looking to build an institutional firm.
One of my favorite Steph Curry clips is when he finds a dead spot on the court. He has such ball control mastery that he knows exactly when his technique fails and when there are forces beyond his control that fail him.
Cover photo by Martí Sierra on Unsplash
Huge thanks to Dave McClure for inspiring the topic of this post and also for the revisions.