Diversifying Investments Over Time
AUGUST 9TH, 2018
I often get asked questions around how many investments Brightstone makes in a typical year and how many investments we intend to carry in a single fund vintage.
Our firm usually makes one new investment per quarter, which equates to one to two new investments per partner per year, or four to five new investments per year in total. Early-stage investments require a lot of front-end diligence and a lot of each partner's personal involvement over a five to seven year period- thus, each partner can only take on so many projects. If you assume the average hold period for an early stage investment is five years, and if you make one to two investments per year, each partner will have between five and ten portfolio companies to manage at any one time.
That said, partner time constraint, while a very real issue, isn't the main motivation behind our investment pace. The main motivation is the desire to diversify a portfolio of investments over time. We do this for a number of reasons, first and foremost because technology trends can change a lot over the life of a fund's five-year investment period. Looking back to our vintage 2013 fund, had we invested the entire fund in the early years of our investment period, that fund would not have had exposure to technologies such as AI, VR/AR or organoids, all of which came of age towards the end of that fund's investment period. 2013 was before app-fatigue had set in, and mobile was still eating the world. Had we invested our entire fund during those early years, we would have been mobile investment heavy, and the app-fatigue era would likely have been rough.
Diversification over time means managing investment pace tightly and saying no to 99% of the opportunities that we look at. Because we make so few investments, it also means being really committed and certain about the projects that we do say yes to. And so that is what we do. Doing this well is hard. If you only make four to five new investments per year and expect to produce at least one significant exit each year during the fund's harvest period, you have to have a pretty high hit rate on early stage investments. This is something we've been able to excel at to date, as evidenced by the strength throughout our 2013 fund. We are already seeing this strategy play out within our current fund as well.
Our approach to making this work is an evolving thesis that tells us what to invest in and what not to invest in, rigor and collaboration in our diligence process, and real substantial value-add post-investment. This is not spray and pray, this is not following the herd, this is not momentum investing. This is thesis-driven, active early stage investing, which has always produced the best returns over time and I believe always will.
