The Question of Risk
Prompted in no small part by some challenging questions posed by @victorbrooker and @SmallTimeVC, this blog discusses our perspective on risk and reward. Before we get started, I’d like to point out that this won’t provide any specific details on our portfolio… we keep that for the accountants. What we will discuss is the politics and influences of risk in venture capital.
Australian VC and risk
Victor Brooker (playing devil’s advocate) asked us: if around 75 percent of Australian tech startups fail, and 90 percent fail overseas, does that mean Australian venture capital investors aren’t taking enough risks?
Well, we know we quoted them, but the jury’s still out on the figures, there are contingencies such as VC-backing, company age, and date founded, all returning significantly varied figures. There are plenty of estimates (some data-supported, others not) that vary between 75 and 90 percent for both, suffice it to say more than three-quarters of startups fail worldwide, but there’s no consensus on specifics.
For that reason, we’re going to step away from the ‘us against the world’ argument. Frankly, we can’t find the statistics to back up that discussion. What grabbed us was the idea of risk. What would Australian VC funds accept as failure rates? What do we do to mitigate it? And what should startups take from some daunting statistics that seem to suggest, no matter where you are, you have a low likelihood of long-term success?
What we’ll accept
So what failure rates are investors at home and abroad prepared to accept? Well of course that varies between funds. Some accelerators may be willing to accept a higher failure rate due to generally smaller investments and the need to maximise exposure. Adrian Stone (@SmallTimeVC) of Angel Cube Melbourne says they work with a 10 percent success rate, but hope for more.
At Oxygen Ventures, we’re very hands-on with startups, often bringing them into close working quarters alongside our other investments… we look for a much higher percentage of success. Many VCs would happily accept the 14 percent chance of acquisition implied by this report. Others might take more risks to see a single digit percentage of their portfolio deliver most of their ROI.
Eggs in one basket…
Ask any investor and they’ll tell you. Portfolios have to be diverse. Whether it’s time, stage, sector or total number, all investors make sure they’re protected against potential bubble bursts by diversifying their investments. But there are some arguments against that perspective, and the role of the investor plays a big part of that.
At Oxygen Ventures our specialism is a big part of what we offer to startups, others like BlueChilli are in a similar position. We’re firm believers that “sometimes the best way to get your eggs from point A to point B is to put them all in one basket and take really good care of that basket” (credit John Denker). We mitigate risk by providing specialised resources to startups to ensure better success rates.
Nonetheless, we still reduce our risk by making sure our portfolio has as much diversity as it can within certain limitations.
Another point raised by accomplished inquisitor Victor Brooker, was the hunt for the unicorn. It’s a metaphor we can all grasp: every investor is actively searching for a billion-dollar company. We want to find a Facebook, a Workday, a LinkedIn; and we want to find them in their infancy, where investments go further and rewards are bigger.
A unicorn is as a startup with a $1bn+ exit when the company is acquired or goes public. The incentive is obvious, one investment can provide returns for an entire fund when the numbers are that big. But the reason it’s called a unicorn is because it’s so rare as to be nigh-on impossible to find. On average, four unicorns are born per year. That’s 0.07 percent of venture-backed startups.
That means you’d be very ill-advised to bet on a unicorn saviour for a portfolio full of risk. Still, for all of us, the hunt goes on.
The fear-factor for startups
If you’re bootstrapping in advance of potential investment, the numbers above probably sent shivers down your spine. The last thing founders want to hear is that their funding guarantees nothing… but it’s true. What can we do to make you feel better? Well, we could remind you that failure in this context means a lack of acquisition or IPO. We’re talking about investor returns, not company life or death.
In fact, up to 60 percent of the companies being counted as a failure are still alive in most estimates, they just haven’t been snapped up by a bigger fish or sold to the public within the 5 to 10-year range of most investments. So don’t worry, your company is significantly more likely to survive than perish – only around a quarter of startups cease operations altogether.
The counter-point is, you might want to start again if you haven’t achieved your exit in this time-frame anyway. It’s common knowledge that lots of life’s big winners are serial entrepreneurs who have had their fair share of failures.
The take away
There is risk in any business. VC is no different. It’s in the favour of venture funders to reduce risk for startups and we work towards that in everything we do. But we’re also realistic about expectations for returns.
Startups should be aware of the chances for big wins, they’re slim. The more you understand that, the more you’ll recognise the importance of smart business strategy and partnership with a VC that’s aligned with your needs.
Don’t let high risk and a low chance of billion-dollar exits deter you from doing what you love, let it spur you on and inspire your growth.