In Search of The Black Swan…Not A Unicorn!
When launching a new fund regardless of its stage or size, one of the most frequent questions I have been asked is with respect to the industries it chooses to focus on. Back in 2014 when my partner and I started to dabble in Angel investing and started to expose 7 Gate to the startup communities in both Canada and Silicon Valley, this issue nagged at us since there seemed to be a consensus that an industry focus would give the fund an edge and would presumably lead to better returns on investment.
In the past 2–3 years, I have slowly realized this to be somewhat of a fallacy. These days when LPs or founders ask about 7 Gate and its investment philosophy, we tend to speak in more detail about the type of founders we like to back and facts related to a specific market or technology than to try and pigeon-hole ourselves into any industry specific approach that we never envisioned. As an investor one has to look at one’s ability and assess where her strengths lie and how she can effect change in a positive way for the companies that the fund backs.
Taking a cue from 500 Startup’s ex-managing partner, Dave McClure, 7 Gate also believes that a diversified investment strategy with a higher-volume, deliver stronger cash on cash returns than a concentrated thesis. In the pursuit of the elusive unicorn, it would serve a VC well to increase the volume of investments and allow a larger funnel of deals to increase the chances of landing on one such unicorn.
While it would be tempting for 7 Gate to look at associates with a narrow industry focus to add to its team, we believe it would serve us better to have an exceptionally strong team of partners and associates with experience in dealing with the various stages of growth as oppose to any specific industry. We believe that knowing challenges that companies face as they scale and grow and blow past strategic landmarks and KPIs can add significantly greater value to entrepreneurs than having industry specific knowledge which by definition each company would need to acquire as it ages.
Additionally, in support of a more generalized approach to investing, the cost of creating and running a company has fallen significantly in the past decade and as such capital efficiency has emerged as an investment thesis for several funds. This implies that opportunities have emerged that would allow a firm such as 7 Gate to invest in a much higher number of companies and in smaller batches while maintaining attractive stakes in those investments. Subsequently, this allows us to maintain a significant portion of our fund in order to invest in later rounds of the winners in our portfolio while moving away from the laggards.
Often it is the investment that one would least expect that yields the most impressive return and turns out to be the Black Swan event that very few can predict. Here’s a quote from Nasim Taleb in The Black Swan: “…you can set yourself up to collect serendipitous Black Swans (of the positive kind) by maximizing your exposure to them. Indeed, in some domains — such as scientific discovery and venture capital investments — there is a disproportionate payoff from the unknown, since you typically have little to loose and plenty to gain from a rare event.
[C]ontrary to social-science wisdom, almost no discovery, no technologies of note, came from design and planning — they were just Black Swans. The strategy for discoverers and entrepreneurs is to rely less on top-down planning and focus on maximum tinkering and recognizing opportunities when they present themselves. The strategy is then to tinker as much as possible and try to collect as many Black Swan opportunities as possible. “
