Early Investing

The Ideal Startup Portfolio Size

The Ideal Startup Portfolio Size
By Andy Gordon
Date September 29, 2021

Most meetings I attend aren’t very exciting. But yesterday’s was fascinating because we discussed one of the most important questions an early investor can ask. 

What is the ideal number of companies for a successful startup portfolio? 

Many opinions were put forward. So what did we decide? That it needs further research and exploration.

But there is an ideal number. And it should be obvious to everybody. That number is… one. For the best returns, choose one company. Investing all your money in a single huge winner (let’s say a unicorn with a valuation of at least $1 billion) will give you the best bang for your buck. 

But alas — this method only works in theory. There have been a lot of studies on the odds of one company turning into a huge winner. Different studies come to different conclusions. But they’re mostly in the vicinity of 1% to 2%. The entire range is roughly 0.5% to 4%. 

Many of these studies are based on cohorts of companies that began raising in 2008-2010. Crowdfunding wasn’t even around then! So the data comes from the venture capital (VC) world. It’s just too early to be capturing this kind of meaningful data from crowdfunding companies. 

So if one company is not an ideal startup portfolio size, what is? 

To find out, let’s dive into the four key contributing factors to startup portfolio returns:

  1. Quality of deal flow
  2. Deal selection
  3. Maturity of startups (what stage they’re in)
  4. Number of companies in the portfolio.

Two of these are givens. And two you have control over. 

Deal flow is a given. For crowdfunders, it is the sea they swim in. And the sea is full of high-quality startups seeking funding under Regulation Crowdfunding and Regulation A. This would be an entirely different discussion for VC investors. For them, the key would be access to high-quality deal flow. Not all VCs have access to the best startups. Crowdfunders, thankfully, don’t have that problem.

Deal selection is not a given. It depends on you, the investor. Studies have shown the more time you spend researching startups, the better your chances of success. I couldn’t agree more. Studies also show that more than half of VC-backed startups fail. One CB Insights study puts the number at 67% (companies that are either dead or self-sustaining). Only 48% manage to raise a second round of funding, according to the same study. The dropout rate for the 90 holdings in my First Stage Investor portfolio? It’s about 10%. And I’m convinced it’s because I put in the research. (If you’d like to learn more about First Stage Investor and get access to those companies, click here.)

Startup stage is a given (for now). VC investors choose the stage they prefer. Crowdfunders have no such luxury… at least not right now. The vast majority of raises are seed or Series A. But with Regulation A raises now allowed to top off at $75 million, this will change. And later-stage companies will have the option to raise amounts from crowdfunders that were once attainable only from VC firms. Why does this matter? The later the stage, the higher your win rate. The earlier the stage, the greater the need to add more startups to your portfolio to capture winners. Which leads us to our original topic…

Number of companies invested in. This is where it gets interesting. The vast majority of VC investors target later rounds. This significantly increases their chances of hitting on winners, including big winners. Yet unicorn-hunting is still an extremely difficult sport. The number of companies that become unicorns is around 1% or 2% for most VC firms. Those are tough odds. But to make their funds profitable, VC firms are forced to go after future unicorns. 

Crowdfunders don’t have to play that game. We invest in startups carrying valuations of $10-to-$20 million, for the most part. VC companies often invest in companies worth $100-to-$200 million or more. This is a critical difference. Crowdfunders can target $100 million exits and make handsome profits. The CB Insights study I mentioned shows that 6.6% of companies (that began raising in 2008-2010) had exits of $100 million or more. Crowdfunders make at least 5X returns from this group.

At those odds, if you construct a portfolio of 100 companies, six to seven would exit with returns of at least 5X. Four of these companies would have exits of at least $200 million. And an additional three to four startups would exit with at least $50 million valuations. 

And the Ideal Startup Portfolio Size Is…

Remember, these probabilities are based on historical data. The crowdfunding scene today has much better deal flow than the VC early-stage ecosystem of 2008-2010. And there’s far more transparency that’s built into crowdfunding than there ever was (or will be) with venture capital investing. That also increases your odds. And if you do the research you should on the startups that interest you, you enhance your chances of success even more. 

For an ideal startup portfolio size, I’d aim for 40 to 50 companies. But the more startups you add to your portfolio, the better. 

The historic VC-based data says that with 100 companies, you should expect about 10 to give you valuations of at least $50 million. A 50-company portfolio would generate five winners, with two of them carrying valuations of at least $200 million. 

I believe that represents the low end of your profit range. You’re far better off being a 2021 crowdfunder than a 2010 early-stage VC investor. I think crowdfunders can do much better than VC-based data suggests. And perhaps the best way to give yourself the chance of doing better is to build a big portfolio.

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