Diversification is key to mitigating risk and maintaining a healthy startup portfolio. As media coverage is saturated with news of unicorns like Facebook and Alibaba leading to huge paydays for investors, it’s easy to look past the risk to the possible reward. But it’s important to remember that the majority of startups fail. According to performance analysis by the Kauffman Foundation, 52% of all venture exits are at a loss. How can you integrate diversification into your portfolio?
Diversify Across Asset Classes
When setting up an investment portfolio, it’s crucial to diversify across asset classes. That usually means containing your venture exposure to no more than 5-15% of the overall portfolio. Unlike stocks, bonds or Mutual Funds, venture investments are highly illiquid. If your kid heads off to college in two years, avoid investing his college fund into the venture market. The average investment horizon for a venture investment is 3.3 years according to the Kauffman Foundation report. Although 3.3 is the average hold period, it’s not unusual for angels with histories of strong returns to hold their investments for 5, 10 even 20 years. This often involves reinvesting in several rounds with the same company before generating any significant return.
Diversify Across Startups
There is no magic number for how many companies to invest in across your startup portfolio. According to research by the Angel Capital Association, “a typical angel portfolio is made up of ten or more investments of a minimum of $25,000 per investment.” Data compiled by Venture capitalist, Kevin Dick, shows the benefit of diversification. This graph shows the direct correlation between larger portfolio size and positive return. As a rule of thumb, invest in at least 15 companies though you are more likely to stumble across that big winner with 50 or more holdings. Remember, don’t put all your eggs in one basket.
The Babe Ruth Effect
“How to hit home runs: I swing as hard as I can, and I try to swing right through the ball… The harder you grip the bat, the more you can swing it through the ball, and the farther the ball will go. I swing big, with everything I’ve got. I hit big or I miss big.” Babe Ruth
Chris Dixon from Andreessen Horowitz discusses the Babe Ruth Effect as a crucial concept of venture investing which is often overlooked. Startup investors must be aware that they will encounter far more losses than wins. The key to success are those rare home runs. Portfolio data from prominent VC Investment Firm Horsley Bridge shows “~6% of investments representing 4.5% of dollars invested generated ~60% of the total returns.” In this case, the majority of returns came from only 6% of the portfolio companies. This is close to market average. By diversifying your startup portfolio, an investor is far more likely to hit big.
Crowdfunder allows individuals and firms the ability to easily invest in a diversified selection of Deals alongside top Venture Capital firms. We want to empower the everyday investor to have a stake in a company that they are passionate about.