Good morning 👋
I have found that people generally underthink portfolio construction.
Dan Gray is not said people.
He has become one of my best follows on Twitter, and he wrote this masterpiece last week detailing how seed funds should be thinking about portfolio - it’s worth a read, and we detail the high-level points in today’s piece.
Let’s get into it.
TOP
“Picking” isn’t a moat
The rule of thumb for a “right-sized” seed portfolio is ~25-30 companies, and it makes sense why.
Larger portfolios can signal an inability to pick, and LPs get more emotional attachment to a rockstar GP who promises a better picking ability than the masses.
Pattern matching to emulate more concentrated funds like USV forgets the obvious that these others funds are not USV, and they attract world-class founders because of the brand they have built over decades.
Larger portfolios = more work, and the value after the check is diluted the more portfolio companies have due to time and resource constraints.
Dan ran some scenario modeling to prove why this thinking is wrong, and why seed funds are better off optimizing for shots on goal. You can read more about his logic here.
Here are the assumptions for the two scenarios:
Concentrated | Diversified | |
|---|---|---|
Fund Size | $50m | $50m |
Investible Capital | $40m | $40m |
Avg Check Size | $2m | $400k |
Number of Positions | 20 | 100 |
Ownership After Dilution | 10% | 2.46 % (3 % × (1–18 %)) |
Exit distributions:
70 % fail: $0
20 % small win: $50 m
7 % medium win: $200 m
2.5 % large win: $500 m
0.4 % unicorn: $1 bn
0.1 % super unicorn: $2 bn
And here are the outcomes:
Concentrated | Diversified | |
|---|---|---|
Mean Fund Multiple | 2.1x | 2.6× |
Median Fund Multiple | 1.9x | 2.5x |
Chance of ≥ 1x | 81.9% | 99.7% |
Chance of ≥ 2x | 47% | 77% |
Chance of ≥ 3x | 22% | 27% |
95th Percentile Outcome | 4.8x | 4.0x |
Diversified beats concentrated in every single except for 95th percentile outcomes.
Diversified strategies also give GPs a better chance of 2xing or 3xing the fund, which translates into their ability to raise follow-on funds - something that is top-of-mind for all GPs right now.
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💲 6 Types of Investors for Startups: For entrepreneurs seeking seed capital, there are six primary funding sources
🎯 Missing the Point of Secondary Narratives: “Instead of obsessing on how to get out of assets, focus on the hard part: getting in”
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