The building blocks for a high probability performance is based on the following guideline:
The total number of investment – you should target at least 12 investments in your portfolio
The total number of industries and or market sectors you spread across at least 5-6
The mix of investment stages – 20/60/20 – 20% high risk, 60% moderate risk, and 20% low risk
According to the Witbank model, as shown above, it establishes a benchmark for early-stage investors to help them ensure they build a balanced portfolio. The bottom line is that the higher the number of investments in a given portfolio significantly increases the success probability, with a higher multiple of returns.
Applying this discipline for your venture investment will serve as a safety net of some sort to ensure you allocate your capital appropriately and efficiently over time. Our experience led us to take the approach of spreading the capital across a variety of investments, making small investments in larger numbers of companies instead of large investments in smaller numbers of companies.
Example: If your total allocation of capital for high-risk investment is $300K with a check size of $25K per deal you will be able to invest in 12 companies which will put you in the 75% probability of 2.4X return. Instead of a check size of $50K which will allow you to make only 6 deals which will put you in a 50% probability of 1X.
Remember you need to apply the 60/40 rule. 60% of your total allocated capital will go to new deals, and 40% (often called “dry powder”) for follow-on investments to strengthen or hold your position as the company raises a few more rounds of funding, and trust us they will ensure you minimize the impact of dilution in the future.
When you are looking at new deals and new opportunities it is recommended to use the following critical thinking process that should guide every investor as part of their decision-making process:
- Into what Bucket of risk this deal falls into? ie. High /Moderate /Low
- Do I still have some room in this bucket in my portfolio?
- Is my check size will give me a sufficient “bite” at the deal?
What will be my dilution effect based on the company fundraising strategy?
- How crowded is the current cap table?
Now that being said, it is much of an art than a science. All of the recommended models and guidelines will not make any difference if you will not have the discipline to follow them. The high-performance trifecta teaches us that Accountability + Discipline + Action = Performance.
Create a state of accountability for yourself and build a network of support that will hold you to account, be disciplined, follow repeatable and consistent processes, and at last take swift and decisive action, you will perform. If any of the pillars of the model will be lucky or compromise, you’re over performance will suffer. Ie, you will not perform as well as you expected. It is that simple.