Shortly after giving birth to a much anticipated sloth bear cub, Khali, a female sloth bear who resides at the Smithsonian’s National Zoo in Washington DC, ate her newborn baby.
Fortunately, she gave birth to another two cubs, which the zoo’s curators were relieved to see her caring for and nurturing.
Two weeks later, she ate them too.
So what has that got to do with portfolio management? I’m getting there – ‘bear’ with me.
Khali made a call that regardless of her efforts, her cubs were very unlikely to survive and she would end up wasting precious resources on them. In turn that could jeopardise her own chances for survival and passing on her genes.
The Syndicate: Due diligence issue
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It makes your heart sink, but that’s evolution at work. Perhaps though (with a bit of imagination) there are lessons to be learnt in terms of managing your investment portfolio.
After all, you’ve built up a family of bright, promising young businesses with potential for growth and a glowing, profitable future. But not all of them will grow to be strong, adult companies. In all likelihood, most will keep demanding more funding without ever reaching independence.
Just like Khali the sloth bear, it’s time to abandon the ones that won’t survive and focus your resources on the ones that will grow and – just like human children – look after you when you retire.
What are your choices?
Practically, this is about deciding which companies to invest in during follow-on funding rounds. These are your choices:
- Cut your losses and don’t invest more (just like Khali abandoned her baby cubs)
- Keep your percentage shareholding (give the kid a second chance)
- Up the game and increase your exposure (and hope that this one will grow up and pay for your retirement)
It’s important to preserve your resources for the best-performing and most promising companies so you can support their growth.
Making these sorts of decisions is not for the faint hearted. You may have backed a startup because you like the entrepreneur or because it’s trying to do something really useful for society. It’s understandable – you don’t want that hope to fade away. But most private investors are out to make money, and abandoning the weaker specimens in your portfolio is a necessary part of that.
Michael Bury, a SyndicateRoom investor with over 100 early-stage companies in his portfolio, says:
Having a large portfolio helps maintain an objective standing. One company fewer doesn’t dramatically change the composition of the portfolio and there are plenty more in there that are doing good things for the world.
Just like in nature, having lots of children increases the chances that a few go on to do something useful. Having a large portfolio helps with choosing which ones to support and which ones to leave behind.
Choosing which companies to keep supporting
Choosing which ones specifically to support is difficult, especially in portfolios as large and diverse as Michael’s. Information about their performance is key.
A SyndicateRoom investor with over 50 companies in his portfolio, Adam R. says:
When companies come back for further funding, you’ve got to make a decision with limited information. It’s really difficult to make a decision in favour of the business when you don’t have much to go by. That’s why regular, truthful reporting is key.
This is feedback we regularly hear at SyndicateRoom. Companies that regularly report to shareholders – including the bad news – are more successful in securing follow-on investment.
Even if things aren’t going to plan, but setbacks are truthfully and promptly communicated, I sometimes give company CEOs the benefit of doubt and invest further, especially if there’s a sensible plan to overcome the setbacks. But without decent reporting, I don’t have a basis on which to invest further.
Michael Bury echos the need for reporting and well-considered (financial) plans:
I tend to support plans. I don’t support a desire for money.
Plans and people
Behind good plans tend to be good people and Michael believes (like most investors) that great teams make great companies. As such, Michael pays particular attention to the ability of the entrepreneur or CEO to realise and accept over time which skills are lacking in their team.
This is particularly common when technical founders refuse to invest in sales and marketing, and instead believe that their products will sell themselves.
At this point in our conversation, Michael and I recall a company that we both came across, which will remain anonymous for the purposes of this article.
Its board of directors was made up of six medical doctors. The company was really struggling from a commercial point of view, which was compounded by the lack of relevant skills at board level and also their inability to admit it was causing problems.
To the best of my knowledge, this company no longer exists.
This is why Michael always looks at the makeup of the board of directors. Non-execs are also particularly useful at standing up for shareholders, and often ensure the smooth running of corporate governance processes.
Another way to look at it: if your children are keeping good company, it might be an indication that they’re onto something and worth considering keeping money flowing their way.
Entrepreneurs tend to be optimists, but something that both Adam and Michael kept stressing when deciding on a follow-on investment is the importance of checking up whether the company has done what it said it would.
For this purpose, it’s worth keeping a note of key items that a company said it’d achieve with its funding round, and measuring against those.
Naturally, building a company takes longer and requires more resources that most people realise. Over-promising and under-delivering exacerbates this simple truth.
Entrepreneurs really are better off doing the opposite: under-promise and over-deliver. They’ll find that investors are much more likely to keep the bank rolling.
Survival of the fittest
A few years on, Khali is now a successful mother, having given birth and nurtured many healthy baby sloth bears. Looking back and remembering her eating three of her offspring seems counter-intuitive to what a successful mother would do, but her objective is similar to that of any investor – maximise the return on her resources. When she saw that her offspring would be unlikely to survive, she simply cut her losses and invested in the ones with the best chances of being successful.