What to expect from us when things go wrong

Frst is a seed-stage VC firm focused on supporting a new generation of French entrepreneurs with global ambitions.

Something went wrong, but what?

Every VC will acknowledge that their success relies on the number of outliers in their portfolio — i.e. the startups they invest in that ultimately reach multi-Bn$ valuations allowing >10x returns on invested capital.

Out of the typical early stage portfolio of 25–30 companies, having 1 such outlier is great, and having several sets you up for legendary performance.

The flip side of this is that a majority of companies barely return the capital invested in them. The numbers speak for themselves: per Horsley Bridge data (courtesy of Ben Evans & a16z), investments returning less than 2x account for at least 60–70% of total deals done, of which 40–50% return less than the money invested.

Courtesy of Horsley Bridge, Ben Evans and a16z

You’ve read correctly — Almost half of every VC’s portfolio company will not return the capital invested, with 20% doing just slightly better. That’s a very large number of companies.

However, VCs rarely talk about what happens in practice with those 60–70% of portfolio companies. And understandably so, because this topic is not as enchanting as praising up rounds and Multi-billion-dollars outcomes.

Still, we feel that brushing this topic under the rug is doing a great disservice to entrepreneurs, and that it is high time people addressed it more openly. After all, navigating those circumstances is de facto a large part of a VC’s job; what is more, this is in hard times that you can test your investor’s character.

So, here is what to expect from us when things go wrong:

#1 — We are level-headed in rough times, because failure risk is built in our investment model

This is the absolutely foundational fact, from where everything ensues: we are shooting for multi-Bn$ outcomes, which comes with being comfortable about losing money on a majority of the investments we make.

Those two aspects are interwoven. That is what portfolio diversification is all about — You can’t repeatably have the former without accepting the latter (although you can have the latter without the former, but that’s another story 🙈).

This is notably why we have a very simple term sheet — optimized for speed and massive outcomes.

But what is not as clear to most people, though, is that this very feature is what gives us a total peace of mind about losing our investment in any given company. That’s a great state of mind to be in when things start to go south, and that allows Founders to openly share their doubts and issues with us.

#2 — We won’t be phony cheerleaders, because it’s a lousy deal for Founders

As mentioned above, Investors benefit from portfolio diversification. But Founders invest their time and energy in a portfolio of one — so they stand to lose much more if their company veers off the breakout path.

In other words, as one very clear-sighted Founder told me recently:

“I do not get any benefit from auto-bullshitting myself”.

So our commitment to Founders is to openly and frequently share our analysis on how the company fares compared to the breakout path.

That’s what we call giving the tough love — the last thing Founders need are yes-men and insincere cheerleaders. Rather, our job is to help Founders see around the corner, which includes letting them know as soon as possible if we believe that their chances to raise the next VC round are slim.

This is of course a very tricky topic, because we cannot pretend to be right in 100% of the cases; but what greatly helps is to frame this discussion through the lens of: “do we think we have demonstrated enough to reach a new fundraising milestone? If not, do we have enough time to course-correct?”.

#3 — We won’t fade away silently in the background

There is no denying it: if and when a company definitively leaves the breakout track with no hope of reversal, we will need to progressively ramp down our involvement — for us to allocate enough time to our other portfolio companies that will drive our fund’s return in the end. That is part of every investor’s commitment to their own investors, and no investor could pretend otherwise with a straight face.

What we will never do, however, is to fade away silently in the background and stop answering our phones. Rather, what we will do in priority in such instances is:

1. lay out the realistic options with Founders,
2. work out with Founders their preferred route forward, and
3. help deliver the top 1–2 actions needed to make sure Founders achieve their goal.

In practice there are 2 dominant options: (i) switch to a different risk/reward profile via an accelerated path towards profitability to reach infinite runway, (ii) a swift termination of the experiment, either through an exit or an orderly wind-down (which is what you want to avoid by addressing the issue well in advance).

If our past experience is any indication, Founders frequently pick the latter (executing an exit or an orderly wind-down), because they have an acute sense of the opportunity cost for how they spend their own time, and often prefer to quickly move on to new adventures. But there is no intrinsically good or bad option; the question is really for Founders to pick whichever option suits them best.

Also linked to this topic is the question of capital — our other scarce resource besides our time. Although our capital cannot be used to fund companies without limitation, we will be willing to help with bridges provided that (i) they are reasonable compared to our overall investment, and (ii) they actually lead to somewhere (i.e. profitability, exit or new round).

Failure risk is an inseparable feature of the VC route

Given all the sweat and tears and love that is poured into building a company, talking about failure is not an easy discussion to have, by any means.

But choosing the “VC route” (i.e. raising successive funding rounds to reach a massive scale at maximum velocity) is a high-reward but also high-risk path, and the risk of failure is an inseparable feature of it.

By publishing our framework for dealing with this risk, and explaining how it articulates with the VC investment model, we hope to create favorable conditions to address this topic openly with Founders when the going gets tough, and help them chart the best path forward.