4-Letter Word

Traditionally speaking, Venture Capital is improperly associated with a four-letter word…

Risk.

For some reason, people often see VC as an overtly risky asset class akin to playing poker blindfolded… with one less card than anyone else.

I find a fallacy in this and here’s why.

Any investment, including VC, runs three types of risk:

1. Systematic risk.

An example of this would be what we call “thesis” risk; it’s somewhat out of our control, but we can contain it by simple “dollar-cost averaging” through follow-on investments and staged investments. 

2. Behavioral risk.

Within all the uniquely wonderful things that make each of us who we are, including our personality quirks, habits, and attitudes, we also all have biases.

These traits make up the individual lenses with which we see the world…and our investment choices.

From an investor perspective, the key is to not let this filtered vision of reality control our decision-making.

I recently wrote a post dedicated to “investor bias” if you’re curious to learn more ;).

3. Non-systematic, or transaction-based risk.

This is the likely main culprit for the reason VC is given such a bad rap.

The fact is that with only a small number of investments, the chances of finding the diamond in the rough become increasingly improbable.

This is especially dangerous when combined with investor bias because then we find most of our investments tied to something we may see with rose-colored glasses.

An easy enough solution exists to virtually eliminate this risk. We call it diversification.

That last one is key to understanding how to properly execute on venture capital. 

Diversification is a fairly common term in the investment world, but many of us only think of it in terms of balancing our stock portfolios and retirement accounts.

Balancing VC funds requires an even higher level of diversification.

In the stock market, a fund that combines 20 or 30 companies provides peace of mind.

VC, at least according to one school of thought, requires a larger number of opportunities.

It’s often hard to go a week in this business without hearing “Power Law”!

However, there are trade-offs. It’s much easier to manage a portfolio of 20 investments than it is to manage 100 or more.

That is where informed management plays its largest role.

Once again, people prove to be the single greatest resource in an industry.

Isn’t that always the case?

The bottom line here is that inherent risk exists in any asset class, but VC is not unnecessarily “risky business.” (Queue movie scene with Tom Cruise.)

With the right people calling the shots, VC is exciting, empowering, and financially fruitful.

As Halloween approaches, remember VC is nothing to fear. 🎃

Thank you Joe Milam for inspiring this post :).