Loss Ratios & Zombies

Back in the day when software was really expensive to build, data was expensive to store and sales were, well, expensive to procure, VCs had big loss ratios. When the going got tough, you had to cut your losses, quick!

These days, its possible to keep a software company running, particularly if its been mothballed, for much longer. If you’re looking for silver bullets, this sounds like a positive thing: you just never know what might happen next month to save your ass. However I think its creating too many zombies in VC portfolios, and this is good for no-one.

There’s surely no-one better to turn to these days for VC insight than Fred Wilson. Sure enough, the Oracle has opined and he is as wise as ever: http://avc.com/2013/11/loss-ratios-in-early-stage-vc/. USV 2004, which is reported to have an incredible TVPI of 14X, had a loss ratio of about 40%, which sounds about right if you’re investing early (seed, Series A).

As costs have come down (according to Mark Suster, by as much as 999%), its become likely that companies won’t go pop so quickly simply because it requires dramatically less capital to keep them alive:

Time is becoming harder and harder to manage, the more time-saving devices and systems we incorporate into our lives. So for that reason, zombie investments are a drag. Start-up experience, good and bad, counts for so much, so its almost always going to be best for everyone to move on and get cracking with the next gig, lessons learned.

Does that mean there is a target/ expected loss ratio for early-stage VCs? Sure — its probably still going to be somewhere around 40%, but its going to take longer to get there, and your winners/ losers are going to be harder to pick in the early days of the fund.