Venture Capital and Diversification
The behavior of venture capitalists (VCs) is interesting in regard to technology risk management and diversification, for many of the companies in which they invest are pure technology plays.
Not only do the VCs seek diversified portfolios overall, but also they strongly prefer a diverse R&D portfolio within a single company—a one-product company is often shunned. However, VCs still are constrained to building relatively inefficient portfolios because start-up capital is concentrated in relatively few fields, such as biotechnology and software, and the performance of stocks within these groups is highly correlated.
We discussed the role of venture capital in creating value from business plans in Chapter 6. However, we are now focusing on how VCs augment their returns because their high-risk portfolios are diversified. We noted that the hypothetical VC’s experience may indicate there is a one-in-ten chance of meeting or beating the plans of the founders, doing an initial public offering (IPO) and hitting a “home run.” There are three chances in ten of a total failure, three chances in ten of a partial failure where the company is acquired and salvaged by a competitor, and three chances in ten that the company survives but produces average business results—a “single.” The VC may create a portfolio of several dozen, or even several hundred, investments on this basis, depending on her financial resources.