Portfolio Aren't Just for VCs
Tim Oren provides a great account of why business models require exit strategies for VCs. I am really enjoying how VC bloggers are sharing practice and theory these days. Public discussions about private equity is a good thing.
He also describes the big capital option for small web service companies to spend their way into barriers to entry and meet large fund investment size requirements. Its a good honest point, but it should be the default option
Good entreprenuers will find ways to position smaller plays for exists. As more small companies develop protectable web service plays, a trend of the commoditization of software, smart acquirers will in general lower the size of average acquisition. There is a roll-up strategy out there.
Entreprenuers also experiment at the margin. Some of the best companies started as smaller plays and gradually ate their way into ajoining opportunities They stumble on opportunties. The problem, however, is that the best opportunities and final form of the company can't be forecast.
If there is one problem I have with the VC model that has less to do with real-world constraints of their business -- its how they want to be the only ones with a portfolio strategy. VCs practice portfolio investment to realize diversification benefits. But they don't want their individual companies to diversify their activities. Doing so makes their portfolio management to avoid concentration of risk more complicated.
Startups should be in fact encouraged to take a portfolio approach to their business. At the very early stage the porfolio of products and market segments needs to have significant synergy to realize economies of production and sales. But as it grows, startups should be encouraged to experiment at the margin and further their diversification. Doing so enables the creation of real options that can be exercised for real value.
This isn't really at odds with the VC model. Each real option increased the probability of acquisition by varying interests. It grows the company in the sustainable manner required for IPO. And in the worst case scenarios the diversification benefit yields a greater possibility of returning the orignal investment.
Tim points out the problem is in a VC portfolio the good companies are taxed by poor performers. If you increased the worst case performance by allowinging entreprenuers to practice established portfolio investment techniques, it could have a decided impact on total return.