Beyond the Limits

• Which game should a VC investor play?
• Which game should an entrepreneur prefer to join?

Let me share some thoughts about two different investment strategies of a VC investor. First of all I will distinguish between two types of games you all might know: gambling games and strategy games.

Roulette is a casino and gambling game named after the French word meaning “small wheel”. In the game, players may choose to place bets on either a number, a range of numbers, the color red or black, or whether the number is odd or even. To determine the winning number and color, a croupier spins a wheel in one direction, then spins a ball in the opposite direction around a tilted circular track running around the circumference of the wheel. The ball eventually loses momentum and falls on to the wheel and into one of colored and numbered pockets on the wheel.

Chess is a recreational and competitive strategic game played between two players. The game is played on a square chequered chessboard with 64 squares arranged in an eight-by-eight square. At the start, each player controls sixteen pieces: one king, one queen, two rooks, two knights, two bishops, and eight pawns. The object of the game is to checkmate the opponent’s king, whereby the king is under immediate attack (in “check”) and there is no way to remove it from attack on the next move.

Roulette and Chess can’t be more different. Roulette is a pure game of luck and Chess is one of the oldest strategy games.

Sorry for palling you with these Wikipedia descriptions – but just take them as an example of the big differences of two VC investment strategies. Just transfer the characteristics of the two different types of games to the investment process of a VC firm.

Basically there are two ways to approach the early stage venture business:

1. You can make a small number of investments and become actively involved in the development of the companies. (Intensive Involvement)
2. Or you can make a large number of investments and let others worry about the development of those companies. (Spray and Pray)

I will focus a bit more onto the heavily discussed Spray and Pray investment strategy which outlines the process of making several small investments with less actual company involvement.

What does Wikipedia say about this term? http://en.wikipedia.org/wiki/Spray_and_pray

Since the second wave of seed and early stage investments in Germany we’ve seen some smaller Venture Capital firms investing in numerous startup companies. These investments have been executed in a very fast and sometimes opportunistic and superficial process. Some VC firms are investing in several similar cases with the hope that one of them will make it. It’s like to have several race-horses in one race. It is comparable with a gambler who bets on different numbers on the roulette table in order to maximize the chance to win.

I do have some serious doubts about the Spray and Pray strategy.

As a venture capitalist you cannot make a large number of investments and become actively involved in the development of the companies because there isn’t enough time for an experienced VC to do both well. Sometimes you can’t even understand the different markets, technologies, etc.

Between 1999 and 2007 I learned my lessons as an entrepreneur and founder of four VC-backed startups and as a business angel investor. During that time I also intensively worked with different national and international VC firms. Beginning of 2007 I became Venture Partner of Target Partners, an early stage venture firm located in Munich. Long story short: based on all my experienceI do prefer the intensive involvement approach and that is what we do at Target Partners.

We plan to make about four or five new investments per year. We might do one more or one less depending on other circumstances, but that is our ideal investment pace. The number of deals is depending on the number of senior investment managers. As a responsible investment manager you are not able to screen and evaluate new business cases, to negotiate and execute the investments and to be actively involved (e.g. as a board member) in more than 1 or 2 (max. 3) new deals per year.

During my time as an entrepreneur we discussed about the to types of VC money: “Smart Money” and “Stupid Money”. Well, I won’t say that VC with the Spray and Pray approach are stupid but I must underline that smart money means more than just money.

Smart money comes from VCs who understand the market of the startup, who are willing and able to support their portfolio companies, who have an experienced senior team, which has done it before. As a matter of fact smart money is a bit more rare compared with stupid money, but I highly recommend to all entrepreneurs to look for smart money. Consider bad times (believe me, they will come): products are not done, revenues are behind budget, strategy needs to be adjusted, key people in the startup team are missing, next round of financing becomes tough, etc. These are the moments when you as an entrepreneur need real smart money. Believe me - Smart Money comes from an investor who plays chess and not roulette.

For me Spray and Pray is a hits business and the VC firm just don’t know who the winners are going to be any more.

The heart of the venture business is being able to separate signal from noise, rolling up your sleeves and working with the entrepreneur to build something successful. Is there any coincidence that Gate5, Xing, SUSE, Interhyp and so many of these “hits” have come from a handful of VC firms? Certainly timing and luck play a huge part in our business, but minimizing it to the numbers of bets is wrong and has nothing to do with serious venture business.