Venture Capitalist’s Dilemma: Which Companies Should VCs Spend Time On?

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One of the decisions that venture capitalists make is which companies to spend most of their time. Although VCs may insist they “love all their children equally,” just like any parent, some favoritism is unavoidable. As humans, we may inadvertently gravitate toward founders we get along with better, or toward concepts that get us more excited than others in our portfolio.

But what holds even more weight is whether the company is doing well. At risk of oversimplifying, let’s broadly categorize companies into the following:

  • Great Company: Rocket ship growth. Clear path to market dominance. Double down and hold on for dear life.
  • Good Company: Doing okay. They haven’t figured everything out yet, but they are making steady progress.
  • Bad Company: Nothing seems to be working. Perhaps something is off, whether it be a founder breakup, fierce competition, abrupt regulatory changes, etc.

It is easy to spend time with the Great Companies. They seem to have everything figured out. Venture capital returns are also subject to power law, meaning the biggest winners drive most of the returns. So, in that sense, you may conclude that it is rational to spend most of your time with the Great Companies.

But that is not necessarily the case. As much as venture capitalists like to boast about how much “value-add” they provide outside of the money they inject, the truth is that the best performing companies will likely perform no matter what the VC does. The founders have figured out the path to success, so they no longer need you to help them find their way. Any time spent will likely yield little impact on returns for the fund.  

An alternative approach is for the VC to spend all his or her time on the Bad Companies. Surely they could use your help. There is so much that needs fixing! Perhaps you could turn them around into a Great Company.

This way of thinking is tempting, but it is likely to be a lost cause or suboptimal use of time. The leap from a Bad Company to a Great Company is a big one. That is not to say that it is impossible, but it is certainly an uphill battle. What is likely to occur in a good scenario is that the Bad Company will turn into a Good Company, but not a great one.

So, the most optimal way for a VC to spend time is to help turn Good Companies into Great Companies. These are companies right in the middle, that may have a strong team, but limited traction and are still trying to figure out how to hit exponential growth. They may need help finding a key hire, closing their first big clients, or securing their next round of funding. Whatever the case may be, spending time on turning them into Great Companies is a worthwhile cause. Because once they hit Great Company status, the outcome can pay off handsomely for both founders and investors.

This is a tough decision for investors because there are certainly other dynamics to consider. If you spend time with a Great Company, although it may have little impact on returns, the founder may publicly express gratitude once he or she is successful. That could attract more founders. On the other hand, if you neglect Bad Companies, they may feel slighted and speak negatively about you. That could repel founders.

The way I have decided to split my time is roughly 20% Great Companies, 70% Good Companies, and 10% Bad Companies. It is important to note that these labels are transient. Companies jump around different statuses all the time. Also, at the seed stage where we invest, hardly any company is a Great Company right away. They need a lot of support to get them to Great Company status. Therefore, the bulk of our work is done the first 18 months after our investment. Hopefully by then, we can wave from the stands like proud parents at a soccer game, thinking to ourselves, “they grow up so fast.”

 


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