There’s a lot of people now who think that the only way to make money in venture is to have an investment in one or more stand-out successes with exit values of $1bn+, the so called ‘Unicorns‘. The thinking goes that for early stage investors it’s all but impossible to tell which those companies are likely to be, and that the best strategy therefore is to give yourself the maximum chance ending up with a stake in a Unicorn by investing a small amount in a large number of startups. This is sometimes called a ‘spray and pray’ strategy.
At Forward Partners we have a different view.
The first challenge is to the premise that the way to make money in venture is to invest in Unicorns. If you have a small fund then it’s very possible to generate good returns by investing in companies that achieve exits in the £100-500m range.
Let’s run the numbers.
A good fund returns 3x cash-on-cash to it’s investors. If you have a £30m fund (our target) then you need to give £90m back to your investors. Add a bit to cover management fees and you are looking for exit proceeds totalling £100m. If you have 30 companies in your portfolio and 20% of them are hits then you need each of those hits to return £17m on average. That could be six exits at £100m where you have a 20% stake, six at £200m where you have a 10% stake, six at £400m where you have a 5% stake or any combination of the above.
In other words, no need for a Unicorn. We still want to back Unicorns, of course, and many of our investments have that potential, it’s just that we’re not relying on getting lucky.
Which brings me to the second challenge, which is with the premise that at the early stage it’s all but impossible to accurately predict which companies are going to succeed and which aren’t. If the definition of success is $10bn+ I can agree, but at lower levels I think skilled investors who stock pick can materially out perform the market average you will get from spray and pray.
When you boil it right down it takes two things to be a skilled investor: smarts and good information. Let’s take the information piece first. If you have been a successful investor for a while then you will have seen lots of companies up close and had a distant connection with many more. You will also be well networked and be amongst the first to hear about new deals and new trends. These amount to substantial information advantages. However, information is only useful if you have the smarts to exploit it properly. That’s partly about the ability to spot patterns, and partly about the discipline to reflect and think deeply about what you are doing.
I like to think that we have the information and the smarts to be good stock pickers, and that we will have enough exits in the £100-500m range to make Forward Partners a great fund. Then, if we have done our job well, there is also a reasonable chance that our best company will turn out to be a Unicorn. Then the fund won’t be great, it will be amazing.