Why VCs Explaining “It Was Only 4% Of Our Fund” Is Misleading Minimization When a High Flying Startup Implodes.

When a High Flying Startup Implodes. As MultiBillion Dollar Private Companies Shrivel, What Their Investors Aren’t Saying About These Losses.

As more high-flyer private companies find their shine tarnished, investors (or adjacent VC-explainers) remind us that it’s unfortunate but actually a non-issue, so please, let’s move on and not rubberneck the pileup. Wait, what? Losing tens of millions of dollars (or more) is no big deal? Don’t people get fired for that?

The basic math suggests they’re, well, correct, at least if you’re just looking at first order impacts. In most cases, any single company represents a very small percentage of a venture fund’s total size (hold aside this is also because firms have been increasing their AUM at astonishing velocity). In fact, losing money on a meaningful percentage of startups isn’t just expected, it’s potentially evidence that you’re taking enough risk to hit some of the power law winners which will pay back your LPs many times over!

As cofounder of an early stage venture fund myself, I’m here to tell you that while these statements are accurate, they’re also misleading when trying to understand the broad impact these implosions may have upon a firm. Before you start tweeting ‘Man in the Arena’ quotations to me, my experience here isn’t limited to sideline punditry — although Homebrew has yet to be involved in any Unicorn->Zero events, I can think of two investments where we were “all in” across the seed, A and B rounds, only to see the companies ultimately return 0x, losing us almost $10m combined.

giant pink pencil eraser rubbing out a unicorn, digital art [DALL-E]

So when a venture firm tells you a previously high valued investment’s failure is NBD, here’s the checklist of implications that’s not always apparent to outsiders, ordered subjectively from least enduring to most calamitous.

Reputation Effect. Highly qualitative but a firm’s brand can be tarnished by their cheerleading and then awkward distancing from a deadicorn. Personally I believe these are great opportunities to ‘learn in public’ and distinguish oneself with how they might support impacted employees, and other bystanders. Others believe they’re moments to silently delete their Tweets.

Opportunity Cost of GP’s Time. At the average multistage fund, a GP might be making just a handful of investments per year (their ‘shots on goal’ so to speak). While across fund cycles and an entire partnership these sorts of issues normalize out, I can tell you for sure the lead partner might be wishing they had that ‘slot’ back, especially if they are early in their career.

Opportunity Cost of Follow-on Capital. Forget the initial investment being lost, and look more at whether there were subsequent follow-on checks written. Even with aggressive recycling, the average fund doesn’t have capital available to support every portfolio company through every round. That’s why some raise opportunity funds and/or stop doing their pro rata at some point. So the follow-on support that went into a later write-down came at the expense of other companies in the portfolio, some of whom would have been more accretive to the fund.

Opportunity Cost of Non-Investment in Competitors. When you pick your investment in a vertical you mostly have to steer clear of direct and adjacent competitors, especially if you were a lead check and/or a Board member. So if the failed company effectively blocked you from pursuing a startup that became a legitimate successful outcome, that’s doubly painful, again especially for the GP who is supposed to be picking winners in that sector. This is less of a problem when the entire vertical falls apart (think of the last generation of scooter startups).

Relationship Cost of SPVs/Direct Co-Investment and LP Credibility. Especially during the past decade bull run, when everything was up and to the right, venture investors loved to increase their exposure to companies by syndicating SPVs (or direct investment opportunities) to their LPs, friends and other industry luminaries. Those going to zero have some implicit (if not explicit) impact upon future enthusiasm for the VC firm.

Disappearing TVPI. “It was only 4% of the fund” could be true but you might have been carrying it at a current valuation of 100x that. You tend to make different sets of decisions when you feel like you’ve got an existing company that’s returning your fund multiple times over — maybe you don’t take money off the table in another investment, maybe you follow-on in other companies with more or less discipline, etc etc.
Going from showing your LPs quarterly reports suggesting your fund is top percentile to a new forecast is a relationship management challenge. Doubly hard if you’re in the midst of raising a new, larger fund (or recently closed one) on the back of the paper write-ups. The most impacted LPs maybe will ask questions about how much did you know or not know about the shenanigans, and why maybe it was in your best interest to be stay naive for a while? Modern version of the Upton Sinclair quote, “It is difficult to get a man to understand something, when his salary depends on his not understanding it.”

Look, I’m not picking on any specific company or firm, but rather this is what happens coming out of a pretty crazy few years. If a venture partnership is around for long enough they’ll end up experiencing all types of highs and lows, some self-induced and others almost nearly out of your control. It’s part of the business. But as an industry we’ve become experts at content marketing the shit out of our wins, the shiniest versions of what venture and startups can be. It’s my POV we learn much more together by sharing honestly and broadly as a community, even if the “why we invested” blog post from a few years ago sounds dumb in hindsight.