On Funding — The Denominator Effect | by Mark Suster

I recently wrote a post about financing for investors to think about having a diversified portfolio, which I called “goal shooting”. The thesis is that before investing in a startup in the early stages it is almost impossible to know which of the offers you made will go up. Therefore, it is important to have enough offers in your program to allow 15-20% of amazing offers to emerge. If you funded between 30 and 40 bids, maybe only 1 or 2 would generate most of the return.

You can think of a shot on goal as the numerator of a fraction where the numerator is the actual bid you completed and the denominator is the total number of bids you saw. In our funds we make about 12 bids / year and we see a few thousand, so the funding rate is between 0.2 and 0.5% of the bids we evaluate, depending on how you count what it constitutes. ” evaluate an agreement “.

This is venture capital.

I want to share with you some of the most consistent advice I give new VCs in their career path and the same advice applies to angel investors. Focus a lot on the denominator.

Suppose you are a reasonably well-connected person, you have a strong network of friends and colleagues working in the technology industry, and you have many friends who are investors, either professionally or individually.

You are likely to see many good deals. I would be willing to bet that you would even see a lot of offers that look amazing. In today’s marketplace, it’s not that hard to find executives leaving: Facebook, Google, Airbnb, Netflix, Snap, Salesforce.com, SpaceX … whatever, to start your next business. You’ll find engineers at MIT, Stanford, Harvard, UCSD, Caltech, or executives at UCLA, Spelman, NYU, and more. The world of talented people from the best companies and major schools is literally tens of thousands of people.

And then add people who worked at McKinsey, BCG, Bain, Goldman Sachs, Morgan Stanley and what you have is not only a really ambitious young talent, but also great people to make presentations full of data and graphics and who have gone perfect the art of storytelling through data and predictions.

Now suppose you have 10 meetings. If you are reasonably intelligent and thoughtful and in a hurry to get ahead of great teams, I am sure you will find at least 3 convincing ones. If you face great teams, how can you?

But now we assume that you are striving to see 100 offers over a 90 day period and get to know as many teams as you can and not necessarily invest in any of them, but have patience to see how great it really is. I’m sure after seeing 100 companies you will have 4 or 5 that really stand out and suit you.

But here’s the thing: There’s almost no overlap in these first three deals that you think were high quality and the 4 or 5 that you’re now ready to punch on the table to say you should fund. .

Okay, but the mental experiment needs to be expanded. Now suppose you spent a whole year and saw 1,000 companies. There is no way to defend to fund between 300 and 400 (the same proportion as 3-4 of the top 10 bids). In all likelihood, 7 or 8 offers would really stand out as truly exceptional offers, MUST DO, slam-your-first-on-the-table. And of course, the 7 or 8 offers would be different from the 4 or 5 you saw for the first time and for which you were ready to fight.

Venture is a numbers game. So is angel investing. You need to see a lot of deals to start distinguishing the good from the great and the great from the great. If your denominator is too low, you will fund offers that you find compelling at the time and will not meet your future.

So my advice comes down to these simple points:

  1. Make sure you see tons of offers. You need to develop pattern recognition that looks really exceptional.
  2. Don’t be in a hurry to bid. The quality of your bid flow will almost certainly improve over time, as will your ability to distinguish the best deals.

Personally I am also a big fan of focus. If you see a FinTech deal today, a cybersecurity deal tomorrow and then developer tools the next day … it’s harder to see the pattern and have the knowledge that it’s truly exceptional. If you see all the FinTech companies you may know (or even a FinTech subsector like Insurance Tech … you can develop both intuition and experience over time).

Get a lot of shots on goal (bids completed, which is the numerator) in order to create a diversified portfolio. But make sure your features come from a very large set of potential bids (the denominator) to have the best chance of success.

Photo credit: Joshua Hoehne activated Splash

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