The Denominator Effect on Funding by Mark Suster

Why Diversification is Key in VC and Angel Investing

It’s no secret that venture capital (VC) and angel investing are high-risk, high-reward investments. Investing in early-stage startups can be a bit of a gamble, as it’s close to impossible to know which deals will break out. As an investor, it’s crucial to have enough deals in your portfolio to allow for the 15-20% of amazing deals to emerge. This is where the concept of “shots on goal” comes in.

The Numerator and Denominator

A shot on goal can be thought of as the numerator in a fraction, where the numerator is the actual deals you completed, and the denominator is the total number of deals you saw. For example, if you funded 30-40 deals, perhaps just 1 or 2 would drive the lion’s share of returns. Therefore, it’s essential to invest in a diversified portfolio to increase your chances of success.

In the world of VC or angel investing, you need to see a ton of deals to begin to distinguish good from great and great from truly exceptional. This is where the denominator plays a crucial role. The larger your pool of potential deals, the better chances you have of success.

The Importance of Seeing Tons of Deals

If you’re a reasonably well-connected person with a strong network in the technology sector, chances are you’ll see a lot of good deals. However, it’s not enough to invest in just a few deals that seem amazing. In the current market, ambitious young talent is plentiful, and it’s not hard to find executives leaving top companies like Facebook, Google, Airbnb, and others to start their next venture.

To improve investment results, it’s crucial to see a lot of deals and develop pattern recognition for what truly exceptional looks like. Suppose you take ten meetings and get in front of great teams. In that case, you’re likely to find at least three of them compelling if you’re smart, thoughtful, and hustle. But pushing yourself to see one hundred deals over ninety days and meeting as many teams as possible without necessarily investing in any of them can improve your chances of success further. After seeing a hundred companies, you’ll likely have four or five that stand out and you find compelling.

The Numbers Game

Venture is a numbers game, so is angel investing. Investing in a diversified portfolio increases your chances of success. If your denominator is too low, you’ll fund deals that are compelling at the time and wouldn’t pass muster with your future self. Therefore, it’s essential to have enough shots on goal completed deals, in order to build a diversified portfolio.

Key Advice for New VCs and Angel Investors

Here are the most consistent pieces of advice to follow for new VCs and angel investors in their career journey:

1. Focus a lot on the denominator

2. Make sure you see tons of deals

3. Don’t rush to do deals

4. Focus is key

Develop Intuition and Expertise Over Time

Focusing on a specific sector or subsector can also help you develop intuition and expertise over time. For example, if you see every Fintech company you can possibly meet, or even a sub-sector of Fintech like an Insurance Tech company, you can truly develop both intuition and expertise over time.

In conclusion, investing in a diversified portfolio is key in VC and angel investing. You need to develop pattern recognition for what truly exceptional looks like and not rush to do deals. It’s crucial to focus and see tons of deals to increase your chances of success. With these key pieces of advice, new VCs and angel investors can improve their investment results over time.