The Christmas tale of Giuseppe and Paolo.
#49 Angelinvesting.it - From idea to Series A - Weekly Newsletter
3 Minutes to reflect
Giuseppe is a renowned venture capitalist, managing a fund of 80 million euros, which has been invested across 40 different companies. Paolo is a founder and CEO who received a 2 million euro investment from Giuseppe. Along with his two co-founders, Paolo retains nearly 70% ownership of his company.
Regrettably, Paolo's project is struggling, and its closure looms near. Giuseppe is disappointed by this turn of events, yet his fund is performing well overall, buoyed by two rapidly growing unicorn investments. Paolo, on the other hand, is facing a difficult time. With limited personal savings, he faces the prospect of laying off his team and seeking employment elsewhere.
The interests of founders and investors are not always closely aligned. Understanding this disconnect is fundamental to comprehending the venture capital landscape.
Venture capitalists employ portfolio theory in conjunction with the power law to mitigate their risks. In other words, they leverage the successes of their investments to safeguard their positions.
A couple of highly successful projects generating massive returns are sufficient to compensate for their failed investments, pay substantial management fees, and provide a return that justifies the risk to their investors.
It's an unfortunate reality, but the rules are stark and straightforward. They are implicitly outlined in bold within the lines of the investment contract. If a founder fails to understand this, it's a significant oversight on their part.
2 Resources to pro
1. Truly understand the power law is not easy as it seems
The power law describes the distribution of investment results in funds where just 2-3 portfolio investments generate the returns of the entire fund, while the rest either fail or yield mediocre results.
The chart represents the average performance of a fund with 30 to 40 investments. Only 41% of the fund's investments manage to return 2X or more, only 23% return 4X, and 11% manage to return 11X or more. The 3-4 investments that achieve a 5X+ return are the winners that define the fund's performance.
In summary, the strategy of VCs is a game of risk management. They create a portfolio of high-risk investments, aiming to identify one or two 'dark horses' capable of generating returns so substantial that they cover everyone's expenses
The game of the founder is quite different. The founder does not have a portfolio of investments. Their wealth is extremely concentrated on the shares of the company they co-founded. If the company does extremely well, they will be very rich; if it performs poorly, they will need to look for a new job. Two very different positions
Read more here: https://www.angellist.com/blog/what-angellist-data-says-about-power-law-returns-in-venture-capital
2. “Default alive” is the founder way out from the VCs carnage
’If the company is default alive, we can talk about ambitious new things they could do. If it's default dead, we probably need to talk about how to save it. We know the current trajectory ends badly. How can they get off that trajectory?’
In this inspiring article, Paul Graham, the founder of Y Combinator, explains how founders have a way out from the brutal 'squid game' of venture capital. Check it out. http://www.paulgraham.com/aord.html
1 Reason to be happy
Merry Christmas! Take some days off and enjoy time with your loved ones
Have a great weekend,
Simone
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