We had a pretty far ranging conversation but the most interesting part of it was in response to the question “why do startups fail?”
I have seen my share of failure over the years, it’s part of the venture capital business. When we raised our first Union Square Ventures fund, I told prospective investors to expect 1/3 of our investments to fail. I always like the 1/3 rule, which is that 1/3 of the investments will fail, 1/3 will under-perform expectations, and 1/3 will meet expectations. Meeting expectations means 5x to 10x on our money. If you are into math, you can look at it this way:
1/3 average 7.5x – 2.5x1/3 average 2x – 0.667x1/3 average 0x – 0xTotal result – 3.2x
The important part of that equation is that you have to have high expectations going into an investment. If your expectations going into a deal are 3x on an average investment, you will fail in the venture business.
In reality, I’ve been able to do better than this over the years. But when talking to investors, it helps to set achievable expectations.
I went back over the past 17 years during which I have been doing deals by myself. During that time period, I have originated, led, and managed 32 investments, about 2 deals per year. I find that is pretty standard in the early stage venture capital business, 2 new deals per year per partner.
Here are the stats:
5x or greater – 11 deals – average 10.2x1x to 5x – 7 deals – average 2.6xFailures – 5 dealsUnrealized – 9 deals
Three of the unrealized deals are 1999 vintage Flatiron investments which will almost certainly end up in the 1x to 5x category so if I add them to that category and leave out the six unrealized Union Square investments that I manage, the distribution looks like this:
5x or greater – 11 deals1x to 5x – 10 dealsFailures – 5 deals
That is decidedly not 1/3, 1/3, 1/3.
It is more like 40%, 40%, 20%.
I doubt that is sustainable going forward. If I take out the six investments I made in the “golden years” of 1996 to 1998, then the numbers look like this.
5x or better – 7 deals – average 7.1x1x to 5x – 9 deals – average 2.5x (on the 6 realized investments)Failures – 4 deals
That is 35%, 45%, 20%, which is more like what I’d expect to see from a good early stage investor’s track record.
In my next post, I am going to talk about why startups fail and how to reduce the failure rates.