VC and the Diamond-Water Paradox
The Puzzle has a Name
Generally (and I realize this is an oversimplification, but…), a fund’s existing portfolio is the driver of return. New companies (or any new asset) represent only potential return. It’s a puzzle, then, that VCs spend so much more time on sourcing new companies than managing the positions of the ones they’ve already got. But, it turns out that puzzle has a name.
It’s due to the Paradox of Value—or its better name: the Diamond-Water Paradox.
The Diamond-Water Paradox
The Diamond-Water Paradox describes the contradiction that although water is undeniably more useful than diamonds, diamonds are valued more…by orders of magnitude.
Existing portCos inherently embody more utility for a fund than the hypothetical startup “out there,” but sourcing and selecting the new, shiny thing is valued more. I saw a job description for a VC analyst role that said: “We place start-up selection at the core of our attention. At all times.”
The goal of a VC fund is to invest in high-growth companies and maximize alpha. VCs seem to be constantly on the lookout for the next big thing—the game-changing startup that will revolutionize an industry and provide a massive return on investment. So, I believe the thinking goes: why waste time on portfolio management when the focus should be on finding and investing in the next big thing?
VC = Portfolio Management (those other functions are the ancillary ones)
Here are just 3 reasons why portfolio management is not a waste of time, and should be a VC’s primary function:
Unicorns aren’t born; they’re made. Neglecting existing investments leads to missed windows to identify issues or opportunities for growth and offer support as needed. Speaking of unicorns….
Let’s usher in the “Era of the Hummingbird”: small but mighty. VC has long been in the grip of the absurd “100 bets, 99 losers, 1 unicorn” model. With proper portfolio management, the industry can finally move to a more sustainable model in which we perhaps get a few more unicorns and 20 or so solid companies to boot. (Read Collab Capital’s “Expanding the definition of success” section for great words on this refreshing kind of thinking.
The Informed Investor. Vigilant portfolio surveillance makes VCs better investors. It enables them to stay informed about developments in their portfolio companies, but, more importantly, in the broader market. Lastly, it helps VCs communicate effectively with their LPs, where the VC can embody the role as the expert in their asset class, sector, or region.
(P.S. Let’s make “Hummingbird” a thing)