How do you know if one of your investments is a winner? And when you find one, what’s the best way to double down?
I dug into some real venture capital inside baseball with top angel Jason Calacanis on the latest This Week in Startups.
One of the best ways to increase your returns in venture is by using reserves. Reserves let you double down on your best companies, goosing your returns.
JCal invests in a ton of startups, often beginning at pre-seed.
He’s planning about 200 for his current fund. Of those 200, he’ll double down on somewhere between 10 and 30 (5 to 15%).
So which ones does he pick?
That’s where the “likely winner” vs. “definitive winner” framework comes in. This framework helps identify the best companies coming out of the seed stage.
Likely vs. Definitive Winners
1) Definitive winner. Jason had 4 unicorns in his first fund: Robinhood, Calm, Density and Superhuman.
When it came time for them to raise money again after Seed, it happened the same way for all 4:
- Series A Priced Round.
- Known VC firm leading. This firm will usually buy 10% or more of the company in the round.
- Known VC joining the board. Since VC’s can only take a few board seats each, a top VC deciding to give this company one of his precious board slots means a lot.
Jason likes to go super pro rata on his definitive winners. That might mean a $1 million investment when the initial investment was $100k or $250k.
2) Likely winners. These companies aren’t quite as strong as the definitive winners, but they’re still doing great.
When these companies do their next round after seed, here’s what it tends to look like:
- SAFE, founder generates terms.
- No lead.
- No board.
- Passing the hat.
- New investor involved.
These are still great companies, and Jason likes to re-invest in them. But for these, he’ll do his pro rata or a little less, in most cases.
The Rest
So, what about everybody else?
The weaker companies tend to raise bridge rounds. These are usually SAFEs and they don’t include any new investors. Some may do equity crowdfunding as another avenue to raise capital.
Jason doesn’t re-invest in these companies.
What Not to Focus On
I thought that growth would distinguish the definitive and likely winners. But Jason explained that growth is not a reliable indicator:
‘“…let’s put aside growth because in the likely and the definitive winners, there’s always some amount of growth. It could be 2x. It could be 5x.”
Getting hung up on exact growth rates won’t help us find the best companies at this stage. Round dynamics are a better clue to who the winners are.
How I’m Applying Jason’s Lessons
I don’t do as many investments as Jason.
I don’t have the staff or the capital to pull that off. I also tend to invest a bit later: typically seed.
So, I’ll probably re-invest in a slightly higher percentage of my companies than he does. For me, it might be 10-25%.
After all, my investments are already a bit more proven out than most of his. On the other hand, my upside is not as high as JCal’s.
But I do keep 50% reserves, just like he does. And when it comes time to dispense them, I’ll be following the likely vs. definitive winner framework to the letter.
Wrap-Up
Our business changes every day. But year after year, the best companies tend to look the same. They raise a Series A from a good VC firm and one of the partners joins the board.
When one of my companies pulls off that difficult feat, I’ll be thinking of Jason’s advice:
“You gotta back up the truck.”
JCal
What do you think makes a winning startup? Leave a comment and let us know!
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More on tech:
I Was On This Week In Startups!
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