As Fred Wilson outlined in a postalready ten years old, such a strategy is fine for VC teams investing at a later stage: they get their money back and change, in line with the “lower risk/lower returns” principle.
For early-stage VCs though, who promised at least 25-30% IRR to their own investors (LPs), the best way to succeed is investment productivity.
Given that half the portfolio will burn to ashes (strikeouts), and a good chunk will make 3-4x the money invested (second- or third-base hit), a couple of bets need to return the entire fund 1x or 2x (home run).
Slugging Percentage Should Be The Focus
VC firms can’t reach those kinds of returns by playing it safe.
Limited both in time and capital, investors therefore need to carefully pick which startups they invest in.
Just like Hall of Fame hitters, the top venture capitalists are patient enough to let a good – but not great – investment opportunity pass by.
They want to make sure they have enough time and capital to commit to a potential home run.
In baseball, the statistic that best captures the ability to take risks that pay off is called slugging percentage.
It is calculated by multiplying the number of base positions by that position, and dividing the total by the number of times the hitter was at bat.
The mathematical formula is:
What the slugging percentage captures is, therefore, the players’ hitting efficiency: when they hit, they hit big.
A high slugging percentage requires more than just hitting mastery. The key qualities are patience, the willingness to take huge risks, and the capacity to absorb strikeouts.
These qualities don’t come naturally to venture capitalists, who often feel they need to invest as much as they can to tip the probability scale in their favour.
In an industry where losing money is part of the job, many believe they should go for quantity over quality.
But not experienced venture capitalists.
US venture capitalist Jules Maltzcompares the experienced hitter, who carefully studies the opposing pitcher’s style to win an edge, to the experienced investor, who becomes knowledgeable about a market’s trends and dynamics before investing in it.
The Best Investment Strategy
If you are still not convinced that holding off until you make a big play is the right strategy, take a look at the table below.
We analyzed a variety of statistics for the five MLB players with the highest number of strikeouts.
Two of them are Hall of Famers, two more have at least one MVP title.
Make no mistake: these are star players.
Interestingly, although their batting averages are less than impressive (two of them are not even in the top 1,000 players ranking), their slugging percentages are among the best.
They are all in the top 150, three of them even in the top 50.
What this analysis shows is that the willingness to make big bets pays off over the long term, even though you hit less than others.
For VCs, this is probably similar to having less Techcrunch articles citing your name.
Where “a” is the number of times an investment makes a 1x return, “b” the same number for 2x return, etc.
Such an approach should normalize for luck and expose the playing-it-safe approaches.
Oh, and if you like baseball and statistics, watch Money Ballone more time! It will remind you that what matters in baseball is going beyond the obvious and getting together a team that plays well together.
Just like in venture capital.
(1) Diehard baseball fans will object that “at bat” is not the same as “at plate”. They are right, and the difference is explained here.