During a recent brainstorming session with one of my VC friends, the topic of bandwidth allocation between high-performing “stars” and struggling “underdog” portfolio companies came up. In the flow of the conversation, I ended up saying this:
Star portfolio companies will likely generate returns, while the struggling underdogs offer the opportunity to learn & build reputations.
There is an inherent dichotomy in managing a venture portfolio – the best-performing companies require little investor bandwidth & yet, have high probability of success while the ones struggling demand an inordinate amount of effort & yet, have low odds of success. Brad Gerstner of Altimeter said this in a different way during a recent fireside chat with Mubadala:
If this founder relies on us to succeed, then we chose the wrong founder. Our job is to increase the probability of success, not create the success.Brad Gerstner, Altimeter Capital
Given this dynamic, it’s natural that purely from an opportunity cost optimization perspective, venture investors will be drawn to divert bandwidth away from struggling companies & towards forward-looking activities like triaging & protecting likely winners or sourcing new deals.
However, as an operator-investor focused on the pre-seed & seed spectrum of financing, I tend to view this tradeoff differently. Personally, I believe in spending time with struggling portfolio companies & supporting their founders as they guide the ship through choppy waters. Not for emotional or moral reasons, but because it makes execution sense in really early stages of venture investing:
1/ Because it’s unclear who will eventually win: till Series A, which is typically an acknowledgement that the company has reached product-market-fit, both “high performing” & “struggling” are loosely defined, temporal phases of company building. Companies will move in & out of these buckets during the up-and-down journey towards PMF. Only by spending enough operating time can an investor develop independent judgement on each company’s potential, quality of execution & what all stakeholders should be doing to tip the scales & increase the probability of achieving PMF.
I call this “building conviction” – something that Paul Graham clearly did for Airbnb by closely observing how the founders were building & iterating on the ground. This is what gave him the conviction to bat for the team in front of top VCs even when a majority of them were just not seeing it.
The alpha of OG venture investors like Paul Graham is their ability to see the kernel of a “top” company within a “presently struggling” one. This happens only by spending the time to closely track the founder’s execution approach & mindset. Reproducing some of the email exchanges between PG & Fred Wilson of USV, to highlight this (Source: Paul Graham’s post from March 2011)
2/ Because you learn what is not working: venture investing is a feedback loop business. It’s an infinite game where the goal is to keep improving daily by learning what works & doesn’t as the world evolves & incorporating the lessons back into your systems.
In my experience, spending time with companies in troubled waters helps absorb lessons not available anywhere in the physical or digital world. Be it co-founder conflicts, screwed up cap tables, botched hiring or excess spending, these human experiences are worth their weight in gold, and reflecting them both in front of other portfolio founders as well as in your own investment process going forward, is key to tilting the playing field a few degrees in your favor. Cumulatively, this can add up to a huge competitive advantage over a long period of time.
3/ Because fighting till the last breath is a DNA: while what Brad says above is true, especially for growth stage companies which is where Altimeter operates, even the best founders pre-PMF need a lot of support & coverage for their gaps & blind spots. The best venture investors strive to create delta on the “increase the probability of success” part of the job, which is why while capital is a commodity, individuals GPs that move the needle during a company’s long lifecycle are rare & so in-demand.
I remember listening to Doug Leone of Sequoia at an event a few months back where he mentioned believing in fighting alongside the founder till the last day of the company (also reflects his tough New York Italian upbringing!).
My organic investing style is cut from a similar cloth, wherein I focus on bringing a company-building DNA to every cap table I have been a part of. Though, it hasn’t been without some self-doubts, as there is no immediate fruit to show for all the labor this approach demands.
Case in point being an erstwhile portfolio company in queue management software. I was literally the first check into the company as an angel way back in 2015, and also helped syndicate that first round. About 2 years in, the company was out of cash, all employees had to be let go, 2 co-founders jumped off the ship, and the remaining 2 founders were trying to engineer a pivot from a consumer app to an enterprise use case.
On paper, this would look like a dead duck to any sane person barring 3 people – the 2 remaining founders and me! We kept pushing on, literally on fumes. I remember having many late-night operating sessions with the founders every week for almost an year, in parallel to my day job at Alibaba & also being an expecting first-time father. In fact, I remember my better half asking me more than once – “why are you burning yourself up over a small angel check? Is this worth the opportunity cost of your time as a Director at Alibaba?”.
As I now reflect on these questions, I feel it’s all about the DNA of doing whatever it takes alongside founders. Long story short, the company pivoted successfully, crossing $1Mn ARR at high profitability. The business started throwing up so much cash that investors got multiples of their investments back via dividends, with founders also receiving significant cash-payouts, and deservingly so, for their grit & sacrifice. It didn’t become a unicorn or a household name but left everyone net-positive.
This experience left me with many operating learnings & a lifelong friendship with the founders, whose next company I have promised to back again. Even till today, I use the mental model from this investment while looking for both positive & negative leading signals in any new team I meet. I have no doubt this experience is helping me sow the seeds of future success.
After more than a decade of experience both as an institutional & individual investor, I have only now come around to accept my nature of not giving-up on people & companies that are struggling. It’s part of who I am and perhaps, my alpha as an investor.
I don’t know if this is the smart way to do venture investing or not, but I would like to leave you with this idea – fighting for the underdog companies will at the minimum, help you learn some valuable lessons & build your reputation as an investor that in turn, will create future value in more ways than you can imagine.
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