Pre-Liquid: An Early Understanding of Your Early Stage Returns

One of the biggest issues that individuals or institutions often have with the early stage markets is its lack of a real time score card. Many investors are simply unable to deal with the longer feedback loops presented by investing in startup companies.

With public equities, you know exactly how well you performed at the end of the day. Even in a less liquid (than public equities) market like real estate, you generally have the option of putting the property on the market to test demand. On top of that, market prices of comparable properties are widely, publicly available, giving you the ability to better understand the value of your portfolio. Not so much in the early stage private markets.

(Of course, this daily score card can be a bad thing for undisciplined investors who let day to day events and fluctuations play too big of a role in their strategy — post for a different day)

For early stage companies, follow-on funding rounds that set a new (and hopefully higher) valuation for the company come around once every 18-24 months and a robust secondary market is yet to exist.

When talking with early stage companies — especially the good ones — you will likely find an intense focus on a few core metrics that help drive the direction of the business. In fact, a company’s ability to identify, track, and distribute their core metrics (i.e. surface the right numbers to the right people) is essentially table stakes in today’s market.

Investors demand this level of rigor from companies and the best ones also demand it from themselves. So what are the metrics that investors can use to minimize feedback loops and effectively understand their performance prior to liquidity events that may be 5 – 10 years out?

Near Term Metrics (0 – 12 Month)

Your Pipeline

As an early stage investor, exposing yourself early on to as many companies as possible – from different markets, with different business models, and even at slightly different stages – can be a great way to hone in on your investment thesis (your thesis should always be evolving, by the way).

It helps you paint an overall picture of the market, understand where you can be most helpful, and start to understand some common characteristics of companies you like and those you don’t like.

Effectively tracking your pipeline helps you take all of information you are pulling in and synthesize it in order to glean insight that can further inform your investment decision-making. In addition to simply knowing how many companies you have looked at, how many you have conducted deeper diligence on, and how many you ultimately invested in, doing a good job of tracking your pipeline can help you gain insight into:

  • What types of companies are you continually passing on ?
  • Whether there are common characteristics of companies that you deeply consider and/or end up investing in?
  • What has been your best “source” of deals — funding platforms, other investors, etc.?

Homebrew GP Satya Patel has written about his approach to tracking their pipeline as he works to determine how to most effectively run his small firm.

Your Anti Portfolio

Your anti-portfolio – the companies that you could have invested in but, for whatever reason didn’t – is an offshoot of the venture pipeline that you are tracking. And if your dealflow is any good, it is likely going to hurt to look at after a few years of evaluating dozens (or better, hundreds) of companies.

But know that you’re in good company. Bessemer Venture Partners, a firm that has backed 117 IPO-bound companies to date, shares their anti-portfolio for all to see on their website. Google, Apple, Intel. If you are “missing” on those types of companies, it is likely you are seeing and investing in some other great ones.

At the earlier stages, Christoph Janz of Point Nine Capital has shared his impressive anti-portfolio.

The major purpose of this exercise isn’t self-flagellation but rather as a way to inform your investment decisions going forward.

  • Have portions of your overall thesis been disproven (or proved correct) by the performance of these companies?
  • Are there markets or business models that you need to spend more time learning about to ensure you don’t miss certain types of opportunities?
  • Are you misunderstanding the impact of certain factors – team composition, deal price, traction metrics, etc.?

As Janz notes in his post, every miss can be justified in hindsight but there are still useful learnings that can be pulled out those you passed on.


Mid-Term Metrics (12 – 36 Months)

Follow On Funding Rates

As we noted above, follow on funding rounds tend to occur somewhere in the range of 18-24 months. Your follow on funding rate is the percentage of your investments that later receive further funding at a higher valuation. This indicate

As First Republic’s Samir Kaji – who has written extensively on the topic notes:

“Follow-on rate is strong evidence that an investor is not only adept at picking good companies and adding value to their portfolio companies’ operations, but also at guiding a company to downstream investors for the next round of financing.”

Of course, tracking surface level numbers can only go so far. Other things to consider when looking at follow-on funding include:

  • What was the follow on rate for companies you could have invested in but didn’t (this goes back to the anti-portfolio)
  • What investors made follow on investments in your companies?
  • How did conditions in the market at large impact the ability of your companies to raise additional capital?
  • How significant was the valuation mark up between rounds.

Your Value

It is likely you have heard of companies using Net Promoter Score to understand how well they are serving their customers. NPS is essentially:

How likely are you to recommend our product or service to your friends or colleagues?

As an investor, it is also important for you to understand the perception founders – both those you have worked with extensively and those you have only interacted with briefly – have of you.

NPS – especially the more advanced version laid out by Foresight’s Taylor Davidson – accomplishes this by helping you take an honest look at how helpful you have been to the companies you have worked with. Here are a few examples of questions you can ask to understand your value add as an investor:

  1. Did they perceive you to be prepared?
  2. Was the feedback they offered helpful?
  3. Would they work with you again?
  4. Were you clear about next steps after the conversation?
  5. Would they recommend you to a friend or colleague?

Note: Taylor actually “open-sourced” his feedback survey on GitHub. Check it out here!