The politically-correct line to use when making a startup investment is that it’s based on “conviction.” As an investor, in order to make the investment, you have so much belief in the founding team, or the idea, or the category, or the traction, or some combination of the aforementioned, that you are hereby convicted to make that investment. I am sure some investors in specific cases are struck by conviction as if it were a bolt of lightning; but, I am more certain those instances are not the normal course of action. As someone once remarked to me about a startup investment — that one should feel equal parts excitement and terror in making that investment, or otherwise the investment itself may not be interesting enough.
Once investors reach some level of security in their firm, they can play for upside. They do not need to increase their chances of finding something great in an optimization funnel. “Shots on goal” diminishes in importance. But, for most investors at the beginning of their career — and especially newer micro-funds of today which have scraped together $1M or maybe a bit more, the concept of “Shots On Goal” is absolutely critical.
These new investors need enough “Shots On Goal” in order to (in their mind) give themselves a chance to find one, maybe two, stellar investments in the lot. Of course, this randomness is most intense for those who invest at the early stages. There is simply no way to know the shape of a company or financial outcome when the earliest investments are made. Having enough “shots” is important because, at a primal level, newer fund managers or investors within firms need to demonstrate the ability to find a few good deals to parlay into the next fund or as evidence for promotion.
There is a cost, though.
Increasing “Shots On Goal” comes at the expense of concentration. As most early-stage investors eventually realize, obtaining and maintaining (or even increasing) ownership in a basket of investments is of utmost importance. The theory goes as follows — 1/ most startups don’t make it, no matter how smart the team and/or noble the effort; and 2/ given the high loss ratios of early-stage portfolios, and given that most portfolios follow a power law curve, an investor building a portfolio needs enough shots to find those 1-2 companies which will drive the returns. Therefore, investors care a lot about ownership, should a portfolio company be acquired or go public — maintaining high ownership can help smooth the harshness of the loss ratio in the event of a large exit.
As an aside, “Shots On Goal” can help newer managers by increasing the likelihood they can demonstrate “interim metrics” in the absence of real returns. I know this because I did it myself, not fully appreciating the fallacy of the concept. As a new investor, it can be exciting to co-invest with a great partner and/or to have a premier fund follow a deal you’re in; or for a company you’ve backed to raise a huge amount of money. While the company will ultimately be judged by its underlying metrics, newer investors need enough shots on goal in order to increase the surface area for these interim metrics to emerge.
But, a funny thing happens as an investor matures. They start to slowly realize that those interim metrics don’t mean much. They’re the vanity metrics of investing. And, as life unfolds, as folks get older, as people get married, have children, begin to limit their new relationships, those investors realize taking more shots on goals comes at a cost of not just concentration, but also of becoming a slave to those false metrics. To be clear, newer investors need the shots on goal to have a chance to catch fire, but over time, the way to generate returns is via concentration, by having conviction, and by taking on more portfolio risk.
I’m writing this now because the concept of “Shots On Goal” has come up more and more in my chats with newer managers. The reality is that shots are important early because you need to increase your probability that you can catch something great. Then, over time, the number of shots will likely decrease — partly due to life, and partly because you will realize that’s how you ultimately get paid. And, most critical, it is how you preserve the time and bandwidth to build a deeper relationship with the founding teams you back.
Those teams you back… those teams, if you select wisely, do not have “Shots On Goal.” They don’t have side funds or side hustles. The company you backed is their one shot on goal.
While you may have 15-20 eggs in your basket, they do not. Sure, most won’t work out, and as the investor, you have hopefully built a portfolio of uncorrelated investments that somewhat insulate you from potential collapse. But, the startups do not have this luxury — so while the concept of “Shots On Goal” is important to consider, it is not as important as what I’m going to write here — that while we may get paid because of the 1-2 successes in a portfolio, our reputations as investors solely rests on how we handle the relationships with the remainder of the portfolio. Some shots do not go into the goal. Some players only get once chance to kick the ball into the goal. For those folk, when an investor can, we must help pick them up and help them get into position to take another shot on goal, in whatever share or form that may be.