Early Stage Investments’ Biggest Secret:
Players are starting to recognise that early stage investment SUCCESS follows a power law distribution (where the bulk of the returns come from very few investments/start-ups in your portfolio) rather than a normal distribution (where the bulk of the returns are the sum of the returns from many start-ups in your portfolio)
Example of Portfolio Success:
Portfolio of 20 – You might get 1 returning 100x, the next best retuned 5x and the rest struggled / died or the best investment returns more than the sum of the returns of the rest.
A few ICONIC early stage investors tend to be much more successful than the bulk of most early stage investors (again the power law) because the ICONS found ways to leverage the power law.
Think of it this way (if 1 out of 20 could be your big success, but you don’t know which one, then make sure every investment you make has the potential to return the entire fund.
In other words: Make sure your luck counts! It will be devastating if you took a very small stake in a start-up that ended up returning 100x but the return is far from returning the entire fund.
Example (Mark Andreessen invested $250k in Instagram in 2010, when Facebook bought Instagram 2 years later for $1billion, Andreessen netted $78m (a 312x return), unfortunately his fund was $1,5 billion (this means they would need 19 Instagram(s) just to break even)
For ICONIC Early Stage Investors the winning rule is kind of counter-intuitive: Rule = Make sure every investment can singlehandedly give you your required return on the Full Fund (make sure your luck counts)
Finding investments with a 100X plus potential to return the value of the entire fund
- Most will not make the cut (there are very few) = Obstacle 1 = you will really struggle to get to 5, forget 10
- Forget finding them all in one vertical
- Forget finding them where everybody agrees (market consensus) – low risk low return
- Forget finding them as more of the same – the red ocean of competition
- Forget finding them as a tech trend – they tend to be more a new market trend
- You have to find a potential new market category king in a big enough market (0 to 1)
Perfect Execution Mindset
- The worse thing that can happen, is to sit on a winner and then to fail due to something under your control (cash) = Obstacle 2 = Causing a cash constraint
- Buffer for Success = Find the potential new market category kings and back them with every resource.
For MOST Early Stage Investors the rule is more a general natural tendency: Rule = The required return on the Fund comes from the sum of all the investments (make sure you count your luck):
Finding investment with a 3 to 5X potential (the sum of all the returns)
- Many will make the cut (there is at least 1 out of every 10 you look at) = Obstacle 1 = picking the best from the pack
- Hot Verticals
- Avoid being the lead investor
Perfect Execution Mindset
- If things are going to fail, make sure you limit your exposure = Obstacle 2 = Losses are unavoidable
- Buffer against potential failure = Risk avoidance – don’t put it too much (run lean)
TMARA (MCG – Market Category Generator):
- Finding potential new market category kings in big enough markets (0 to 1)
- Select, Test, Invest
– Select = we found a unique type of problem that by default leads to new market categories
– Test = we do 4 tests to see if the start-up can reach Product/Market Fit in the new category
– Invest = We purchase an option (pay for the testing) to enjoy a discount when we can invest at product-market fit, to scale the business (Series A).
- Perfect Execution:
- Buffer for Success
- Pipeline of concurrent start-ups (4 running concurrently), with a buffer of new ones to replace any one that failed to pass a test
- Go/No Go tests (set the bar high enough to force success or early failure)
iii. Test Cash(seed), Growth Cash (late seed) and Scaling Cash(series A)