Last week, in TFN #49, we wrote about Tiger Global and their quick trigger. Tiger has announced over 60 deals this year, spurring an industry-wide discussion about due diligence.

Likewise, there have been similar conversations in the depths of the African tech WhatsApp groups, albeit around early-stage investors whose pace isn't quite as rapid as that of Tiger Global.

According to research from Max Cuvellier and Maxime Bayen, two early-stage funds - Launch Africa and Kepple Africa Ventures - are investing in over one deal per week, on average. No small feat for small(er) funds with commensurately small teams.

The question of due diligence seems to be a question about risk reduction, and the extent to which an investor can mitigate potential losses before writing a check.

But on the other hand, a long, drawn out fundraising process can be inherently risky for a startup, as it takes attention away from product and business building. And, many may rightly argue, it's counterproductive since a) early-stage venture is inherently risky, b) it's impossible to mitigate all risks a priori, and c) venture fund returns often come from a few big winners, so investors are better off taking a lot of small bets and doubling down where applicable.

I suspect those that are making lots of small bets think about doing so from a perspective of upside optimization, rather than risk reduction. But for those who wish to look at venture investing through a risk paradigm, I think it merits a discussion about risk tolerance versus risk capacity.

On Risk Capacity & Opacity

According to Investopedia, risk tolerance is "the amount of risk that an investor is comfortable taking or the degree of uncertainty that an investor is able to handle."

Risk capacity, on the other hand, is "the amount of risk that the investor "must" take in order to reach their financial goals".

I don't think we should be thinking about risk tolerance, but risk capacity.

In venture, in order to have the sizable returns required of an early-stage fund, investors "must" make "riskier" investments.

Perhaps it's "riskier" to invest in a given startup having spent 10% less time on due diligence. But a venture fund's risk capacity may compel them to continue shortening the time it takes to write checks.

And I think risk capacity is pertinent to discuss on an ecosystem level, as well. In other words, what "must" investors do in order for the ecosystem to reach its goals? What types of investments "must" investors make for the benefit of its portfolio and the ecosystem?

I am reminded of the concept of invisible innovation, which we discussed back in TFN #38. In the case of Twilio, it was hard to see who would be their customers when the company launched 2009. But Twilio sparked "a cycle of innovation that was invisible at the time".

There are both direct and indirect benefits - direct and indirect drivers of ROI - at play here. And these are the types of investments, I believe, the ecosystem "must" make.

I am currently reading a book called How We Got to Now, by Steven Johnson. The book introduces a concept called the hummingbird effect, a phenomenon whereby "an innovation in one field can trigger unexpected breakthroughs in wholly different domains, but the traces of those original influences often remain obscured". Johnson writes,

Johannes Gutenberg’s printing press created a surge in demand for spectacles, as the new practice of reading made Europeans across the continent suddenly realize that they were farsighted; the market demand for spectacles encouraged a growing number of people to produce and experiment with lenses, which led to the invention of the microscope, which shortly thereafter enabled us to perceive that our bodies were made up of microscopic cells. You wouldn’t think that printing technology would have anything to do with the expansion of our vision down to the cellular scale… ut that is the way change happens.

I suspect those who are placing bets toward an imagined yet opaque future, with the trust that those bets will pay off both directly and indirectly, are those who will be the big winners of today.

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Thanks for reading,

Justin

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