I’ve been operating startup investment funds since 2012, and for the twenty years before that, I sat on the founder’s side of the table raising capital from venture capital funds. I thus feel an expertise on the subject of startup investing, and have trouble understanding what others don’t understand about the topic.
Case in point, portfolios.
Specifically, the fact is that startups fail. Thus a terrible strategy for startup investing is to make one investment into only one startup, and stop. Or two investments. Or for that matter, five. Research shows it takes at least twenty investments to have a good chance of earning a profit being a startup investor.
Thus every startup investor is building a portfolio of investments. Yet most investors I talk to are not thinking about the portfolio as a strategy, they are instead solely focused on each investment individually.
These investors think they are smarter than the crowd. They think they can choose more winners than the average investor, and from that end up with the optimal results. We see how that doesn’t work on Wall Street, with no active traders ever consistently beating the passive traders. Not even Warren Buffet in any given five year interval.
Nonetheless, this the strategy I see as I go out and talk to investors about the graduate fledglings. Those investors think a few fledglings are gems, and the rest too early, too small, too <insert excuse here> and not worth even talking to.
This is the normal response, but it is wrong response.
If you are operating a small impact investing fund, if your goal is to earn more money back than you put out to companies, and if your goal is to have as much impact as possible in the process, then stop trying to make the fewest investments possible in a handful of companies and invest broadly in whole portfolios.
Specifically, seek out accelerators and funds who work with companies “too small” for your fund, partner with them to do the interactions you think you can’t afford to do, and spread your capital across 30, 50, 80, 100 companies instead of 20. That will increase your fund’s odds of success, and greatly increase the odds that you’ll find a few gems worth prioritizing with additional capital.
Case in point, East Africa Fruits back in 2014. When the company arrived at Fledge, they are just finished their first year of business, had earned $100,000 in revenues, and was cashflow break even, or close to it. It was far too small for the funders of the day, so a handful of Angels provided it $50,000. That, plus the $17,000 from Fledge was sufficient to grow the company to $300,000 in revenues that year, then $600,000, then $800,000, and just above $1 million four years later. Only then did the investment funds think that company was worth talking to, but it took another two years and revenues growing to $1.5 million before their Series A finally closed. The venture funds missed out on the first 15x of growth, which would have come far more quickly if the company had more capital.
Similarly, no investor wanted to talk to OBRI Tanzania when they graduated from Fledge back in 2018. The company had earned $200,000 in revenues in their second year. “Too small! Too early! Too risky!” was the feedback I received. Fast forward 18 months. With just €20,000 from Fledge, this company earned $1.2 million in revenues in 2019. Again, the investors missed out on 6x of growth.
No doubt if any of those investors are reading this, they are wondering how to invest into those two successful companies, and missing the whole point of this article. Two fledglings were able to grow their revenues dramatically. There are many more gems like that in the list of fledglings. Many more that will grow 10x in four years if only for a modicum of capital, a missing key piece of equipment, etc.
I’m experienced enough to not even try and guess which. I’m smart enough to bet on ALL OF THEM rather than trying to suss out which will be breakout hits.
Not all will successful, but with 101 fledglings and counting, our portfolio as a whole will be successful. I invite the bigger funders to come join us in that overall success. Bet on the big portfolio, and in hindsight you’ll be praised for being brilliant as you rattle off three dozen successful companies you invested in, rather than just one or two.