I remember back in the mid 90s, I used to say with some pride that I had not lost money on any of my VC investments. Then one day, someone told me “then you are not taking enough risk.”
I ended that streak of not losing money on VC investments in the late 90s in a series of epic flameouts. I lost somewhere between $25mm and $30mm on one single investment. I am not proud of those mistakes. They were stupid. I am ashamed of them to be honest. But I learned a lot from them. Not only was my “winning streak” a case of not taking enough risk, it was also a case of not enough learning. The go-go Internet era of the late 90s fixed both of those things for me. I took more risk and learned a ton.
Our first USV fund, our 2004 vintage, has turned out to be the single best VC fund that I have ever been involved in. We made 21 investments. We made money on twelve of those investments. We lost money on nine of them. And we lost our entire investment on most of those nine failed investments. The reason that fund performed so well has pretty much nothing to do with the losses. It was all about five investments in which we made 115x, 82x, 68x, 30x, and 21x.
It wasn’t like we were swinging for the fences in that fund. Every single one of those 21 investments seemed like an intelligent investment decision at the time we made it. But many of them didn’t work. We lost all or almost all of our money on over 40% of our investments in that fund.
The next fund we raised, our 2008 vintage, is now eight years old and we can begin to calculate the win/loss ratio on that one too. We don’t yet know the magnitude of our winners, but there will be a bunch. It will be one of the better funds I’ve been involved with. I doubt it will be as good as our 2004 fund, but it will be a very good fund. We invested in 22 companies in that 2008 fund. We have already completely written off six companies. Those are complete and total losses. And, I think there will be at least a couple more losses in that fund when it is all said and done. So it looks like something like 14 winners and 8 losers. We will likely lose all or almost all of our money on roughly 40% of our investments in that fund.
My point on sharing all of this with you is to explain that losing money is part of being an investor. It happens. As Richie, the guy who sits behind me and my friend John at the Nets game, says, “you can’t make ’em all.”
But there are some things you can do with your winners and losers to drive up your performance.
The first and most important thing you can do is minimise the amount of money you invest in your losers. In our 2004 fund, we invested a total of $50mm out of $120mm of total investment in our nine losers. That wasn’t so good. We could have, and should have, recognised our bad investments earlier and cut them off. In our 2008 fund, I think we will invest roughly $35mm out of roughly $140mm of total investments in failed investments. So even though our loss ratio on “names” is around 40%, our loss ration on dollars will be around 20%. We did a good job of not allocating too much of the fund’s capital to losers in our 2008 fund. And most of those losers were mine by the way.
Ironically, another key to managing your losses is to spend more time with them, not less. By spending more time with them you can develop clarity about the investment, whether it will work or not, and you can get the founders and other investors to see the light early and not waste more of their time and/or money on it. I am a big believer in “loving your losers” in the sense that you should not orphan them and you should work hard to get to the right outcome. Enabling them with good money after bad is not loving them.
Finally, getting clarity on your losers, getting them sold or shut down quickly (with dignity for everyone), frees up more time and money for the winners. And, as our 2004 fund shows, a few really good companies can carry a fund to the moon. You must make sure you can get a disproportionate amount of your time and money invested in those great investments.
When I look at a VC to work with, recommend to LPs, or very rarely, invite into our partnership at USV, I look for someone who has made their share of mistakes. Making bad investments is humbling, frustrating, annoying, time sucking, and most of all, a big part of the VC business. I look for VCs who have done it a lot, have done it with grace and respect, and continue to learn from it. They are the best VCs to work with.
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