How do you determine which startup risks are worth taking?

Five key categories (in order): 1. Management team - Effective at hiring/retaining staff? True visionary / analyst combined skill sets? KPI conscious? Relevant prior experience? 2. Market - big enough returns for my fund size? High growth market? Resistant to market cycles? Proven GTM? Initial CAC vs LTV looking strong? 3. Metrics - recurring business model? Sustainable growth (rule of 40)? GPMs above 70%? NDR? Capital intensity? 4. Technology - genuine issue being solved? Barriers to entry? Scalability? Competition's ability to respond? 5. Deal - well priced valuation? Exit opportunities? Asymmetrical risk profile? Cap table to date? Signals from other investors?

The two main tools for VCs to manage risk is to 1) invest in a portfolio of companies and 2) invest in several funding rounds thereby injecting most of the fund into companies that have already proven product market fit and eliminated technology risk. 1) is self explanatory and 2) simply means investing smaller amounts when the risks are high and larger amounts into portfolio companies that have already proven they can be successful. This basically means that VCs that only invest, for instance, at seed rounds are handicapped against others that can invest at multiple stages.

1. Assess the background of the Founders and the senior management team - includes educational, work history and credentials. 2. Research the space in which the start up is operating and what potential lies. 3. The legality and understanding of the offering and the business - spaces tending towards more grey should be examined carefully. 4. The political thinking around the offering and the business. Important to consider what the policy and law makers think. 5. Financial outlook.

You should seek to solve mission critical risks first. In other words, figure out the most likely reason you’ll fail and solve that first. If you can’t solve it, either the proposition, or you, isn’t right.

Risk changes based on stage so cannot use a one size fits all approach. What doesn’t change is: - Team - it’s all about execution. Track record and ability to play defense and offense as needed. - TAM - without a large enough market there can be no scale so understanding what is the market risks - competition - advantages to approach and demographics of customers. Basically what’s the revenue model. - PMF - I’m more interested in what was tried - didn’t work and why. Refining understanding of what the customers want and building to it - testing and optimizing is what good founders do. - Exit - How does this end and in how much time.

Portfolio construction strategies play a crucial role in maximizing returns and managing risks. The portfolio construction has to be in line with the fund thesis and have sufficient GP bandwidth to support the operations. It's mainly driven by the power law, suggesting that a small number of investments generate a significant proportion of the overall returns. This implies that a few high-performing companies have the potential to deliver outsized returns. Understanding and leveraging the power law can guide GPs in focusing on identifying and supporting companies with the potential for exceptional growth and value creation. Ultimately, construction is about portfolio size, entry and follow-on allocations, and risk-return profiles.

La ultradiversificacion es un superpoder. Es la herramienta que permite gestionar el riesgo en estapas muy tempranas en la inversión en startups. El Private Equity y late Stage VC suelen tener portfolios de entre 20-30 inversiones. Desde mi punto de vista para llegar a una buena diversificación en preseed se debe invertir en 50-100 Startups. No es lo mismo que spray and Pray, ya que sigue una estrategia de construcción de portfolio en añadas, verticales, modelos de negocio y tecnología y siempre basado en equipos muy buenos.

We can enumerate a few key factors and strategies used by VCs to manage and mitigate risks: - Portfolio Strategy - Due Diligence - Investing in Strong Teams - Addressable Market - Scalability of the Business Model - Protectable Advantage - Milestone-Based Funding - Clear Exit Paths - Contingency Planning - Active Involvement A combination of these factors and adopting a portfolio approach is essential to see to it that VCs can balance risk and return across their investment portfolio. Not every startup will succeed, but a well-diversified and carefully managed portfolio increases the likelihood of overall success.

This is a slightly trite statement. Of course risk can be diversified using a portfolio approach provided the risk factors are independent. It also assumes that a portfolio is possible, with that assumption implying a substantial fund. It is not possible to diversify risk in a small fund. In a large fund, there is a two-fold judgement - do I believe in the sector (urgent demand, large TAM, open etc) and secondly is this the right investment to address the sector. In a large fund, it is possible to hedge technology risk by investing in several different (and competing) approaches to the same potential market opportunity.

According to Pitchbook Data (“Introducing the Pre-Seed Data Set” published Sept 2023), about 3.5% of startups raise 7 rounds of financing. Roughly meaning you need 29 investments to get 1 home run. This is more feasible to accomplish if you invest through a fund, particularly if you don’t have sufficient funds and deal flow to do this yourself (assuming you can pick good ones!).

I have found the most important factor increasing the probability of an investment’s success to be the CEO’s natural inclination to be 1) data driven and 2) believe what the data tells him/her and 3) act on that basis without delay. Therefore understanding the CEO’s character is critically important. And the best way to gain this understanding is via evidence from the CEO’s earlier career.

If you are investing in early stage startups, it's easy to identify risks (because there are a lot of them!). The more difficult thing is deciding which types of risks you are comfortable with. At the pre-seed/seed stage, I don't like to take team risk. The product often changes and pivots, but the founding team is what you're investing in. I don't need to see a full team (in fact, that isn't stage appropriate), but I like to see a founding team that can both build and sell the initial product.

Early stage companies typically have greater intangible data. Later stage companies have greater tangible data. Hence, earlier stage businesses are assessed much more on a “pattern recognition” basis which can be difficult to derive into a standard framework or even explain. Founders often pivot as they develop so assessment weighting shifts strongly to the market and team. This is often what makes early stage investing an art than science. Later stage a company the richer the financial or business model data that is available. The more financial modeling analysis, marketing mix assessments and customer calls you can make. Fewer frameworks are needed and extrapolating data using certain assumptions is easier. More science than art.

At some point you need to take a critical look at the startup to see if they are going to be able to scale. This means being razor sharp in analyzing product market fit, making sure the CEO is not overly in love with their product. Second, the CEO is most likely a "launch leader" but are they able to shift into "growth leader" phase when it is time to scale? If not, will they recognize this and allow a growth-oriented CEO to take over.

Startup investments are all about striking the right balance in a landscape brimming with uncertainties and opportunities. Key aspects include(but not limited to): Team Dynamics: The founding team's skills, vision, and chemistry are crucial. Stage-Specific Risks: Different stages, different risks – from market fit in early stages to operational efficiency in later stages. Data and Intuition: Balance hard data with market intuition. Personal Investment Style: Align risks with your unique investment philosophy. Leadership: A strong, data-driven CEO is pivotal. Wrapping it up, navigating startup investments is a bit like sailing in open waters – exciting, unpredictable, and requiring a good balance of skills and instincts

The biggest mistake an entrepreneur or a vc can do is to “fall in the love” for the venture, or to be overly passionate about it. The above would create: - a poor or not enough professional assessment and due diligence - an overly optimistic plan - the inability to see early the venture missing out targets - a way too late decision to cut losses and let the investment go Been there, done that!

In my experience a huge pitfall in our industry is FOMO, being scared to miss a deal. Consistency in deal research and deal evaluation is helpful when building a strong portfolio. Investors sometimes fall into the trap of doing deals to fast without following their decision framework.

The essence of VC lies in mastering timing—knowing when to enter, exit, or step away. Though, what truly captivates me is the micro-level aspect, mastering the art of timing markets precisely. The second misconception is the Babe Ruth Effect: Swing big or miss big. VC prioritizes optimizing for Alpha over reducing Beta. Lastly, VC is about being right and non-consensus. While making money depends on being correct, many VCs fail to grasp that being right about a facially apparent opportunity doesn't necessarily lead to financial gains. Swift arbitrage, triggered by a widely recognized opportunity, often eradicates potential profits. Success in VC hinges on not just navigating the conventional facts but on foresight and contrarian thinking.

All startups share the pressure on founders and key-person risk. Statistically, founders display more neurodivergence than other professional categories. Backing a founder without an assessment of the mental health risks in entrepreneurship is a form of unnecessary risk for venture capitalists. Founders are expected to sacrifice all -- health and family – on the altar of company success. Founders are like elite athletes — superhumans with super discipline, But top athletes have opened up about their struggles and the cost of success, still taboo in entrepreneurship. The VC community should support more conversations on mental health, and VCs can educate themselves, think about their biases about mental health, and better support founders.

The sunk cost fallacy is extremely dangerous when paired with unrealistic optimism and a big ego. Investors that find it hard to accept that they have made a bad investment will throw good money after bad, when they should actually accept that they have made a mistake and move on. It’s not easy to accept that one has made a bad investment and accept a loss, but it’s a humbling experience.

- People, people and people! - Making sure adequate capital instruments are in place. - Stick to the core concept until rigorously proven before looking at other vertical. - Be prepared to throw the towel in if there are big risks or threats ahead. - Set your BHAG, 10 year vision, then break this down into 5 years, 3 years, 1 year and 90 day goals. - Execute your goals and KPIs.

“I’ve seen this idea a hundred times before and that idea never works” is the downfall of VCs in my opinion. You have to remain open to a changing world and understanding that a core human problem will eventually be solved with the right platform or tech shift. I remember when we saw Snapchat and a judge said, “ugh photo sharing is so over” 😂🤣 Of course we accepted them.

This is the 'old style' Lean Startup approach. However, over the last ten years, the systematic methodology of Venture Building ensured better results and metrics in term of time to seed, failure rate and overall IRR. The Venture Building approach doesn't rely on test and iteration, or picking the best available startup, but rather assessing market gaps/opportunities and filling these gaps with new product/services and business models. The Venture Building basic processes are evolving in the most advanced Integrated Venture Engineering (IVE) methodology.

A philosophy that is preached often and especially by Jeff Bezos the founder of Amazon is „Day 1“. The idea that you look at your business as though you were just starting it. Many founders and VC investors talk about product or founder to market fit as though it’s a singular point in time right at the beginning in the pre-seed to Series A rounds and by finding it success follows. The reality is that it’s something that needs to happen throughout the journey of founding and scaling because markets, teams and your competitors change the dynamics you operate in. That‘s why in order to stay relevant experimentation and iteration are important regardless the phase of business you are in. They make the companies that stand the test of time.

Risk-taking is like jazz – it's all about experimentation, improvisation, and occasionally hitting the wrong note. The key is to iterate until you've composed a symphony, not a startup cacophony.

Once the basics are vetted (high team quality, market size over xxx, product favored by die-hard clients, proven iteration capacity, strong IP or know-how), consider these questions: - Which investment play: Is it a R&D play, a commercialization play, a speed play, an execution play? - Which financial risk profile: is it a 'lottery ticket' or a 'solid business'? Consider good-scenario multiples and zero-out probability to better manage your risk. - What is my complementarity and added value to the team? - What is the project maturity: is it in very early stages or are key strategies set? - How does the next funding round look: potential future investors? Is the capital intensity ok? Is there a risk of no-go by VC or institutions alike?

There is a pre-seed Dilution-Runway-Equilibrium for early-stage startups. Pre-seed fundraising can be either founder friendly, investor friendly, or in a founder-investor-equilibrium. Founders tend to opt for high valuation, low dilution and big vanity rounds, while investors (VCs in particular), aim for target / high ownership, optimal runway, high valuation uplift potential and cap table hygiene. Sometimes it’s tough to align interest. Usually as outcomes swing with the market sentiment entrepreneur market (‘20-’22) Vs. VC market (now). Post-money pre-seed valuations, cap table hygiene, burn rate and runway will be key success drivers for follow-on rounds. Especially in the current highly sensible market environment.

A good way to assess if a startup is worth the risk is to look at the exit landscape. Who will buy it and for which reason, how the market is evolving, and the potential for growth or acquisition within the industry. Can it reach a sufficient profitability and cash-flow which could also open way for private equity acquisition.

Focus on customers and interacted quickly. You’ll know when there is product market fit (PMF) - usually many people are calling to pay for a product!

Para los que vais a iniciar el recorrido en invertir en Startups creo que la mejor recomendación es hacerlo de la mano de gestores profesionales al inicio que os permitan aprender y posteriormente empezar a invertir en directo con criterios específicos. Revisa cada año esos criterios! Aprende de los errores, y persevera. Nos jugamos el futuro con este tipo de inversiones que apoyen a nuestros mejores emprendedores