Pacing, Slow and Slightly Slower

Fred Wilson frequently writes articles we read and retweet. It happened again earlier this week, when he discussed his process for pacing his investments. At a pace of one to two new investments per partner per year, Union Square Ventures will make five to ten per year, and maybe about ten to twenty within every fund they raise. USV sees many more deals than that, but they understand their constraints, and limit their strategy and pacing accordingly.

One of these constraints is the same one all of us face: time. With only 365.25 days per year (on average), and 24 hours per day (or close to that), their partners can only spend so much time each year sourcing new early-stage investments. Even after identifying and closing on a new investment, more time and energy is needed to help that company succeed. And, when their funds become close to fully-allocated, they have to spend time away from their portfolio to raise more funds from their investors. This leads to concentrated portfolios that require a high hit rate. Which is not easy.

The investment mandate of the institution I work for is far different from that of USV. We don’t invest directly into early stage companies — we invest through funds ranging in size from several hundred million to several billion dollars, and strategies from buyout to growth equity to distressed credit to venture.

That one common constraint shows itself again though: time. We’re not going to spend as much time as USV actively working with the investments in our portfolio. The relationship between limited partner and fund manager is much lower-touch than the one between venture firm and startup. As a result, in a year’s span we’ll likely make more commitments per person than USV.

However, a higher pace of investment isn’t necessarily a good thing. We need to commit close to $500 million per year to reach the target private equity allocation — despite a private equity team of two people. Two people to monitor a portfolio of managers that only grows larger with each passing quarter. The bar for adding a new manager has to be extremely high, with the contribution to the overall portfolio (beyond just performance) requiring much deliberation. And if that growth is not managed thoughtfully, our effectiveness at sourcing and monitoring will decrease significantly.

These time constraints therefore affect how we invest. We’ll focus our time and efforts on making larger commitments, as $50 million commitments require the same amount of work as $5 million ones. This for one does restrict our ability to invest into early stage venture funds, which are typically smaller and unable to accept large commitments of size. That being said, the potential returns those funds achieve do make this a problem worth solving.

But why not go the opposite direction, and make larger commitments into an even smaller number of funds? Because, very few funds accepting those larger commitments of size have attractive potential returns. Most of the funds that can are $10 billion, $15 billion, even $20 billion, and buy companies at very, very expensive prices with very, very large amounts of debt. The potential returns in high-priced, mega-cap buyouts do not make this a problem worth solving.

So, our ideal commitment size leaves us with the universe of funds that are smaller than $5 billion dollars in size. Their returns are stronger than those on the larger end of the fund size spectrum, and we should be able to make large enough commitments that won’t leave us stretched too thin. Thus allowing ourselves the time to monitor the existing investments and find new opportunities at a reasonable pace.

In a conversation with Chris Douvos this week, he said that time is his scarcest resource. And it’s true, beyond just this narrow application within portfolio construction. The most important relationship any of us manage is the one we have with time. It requires self-awareness, the ability to re-evaluate not just how it’s used, but how we adjust and pace our efforts. Everything else will ultimately flow from there: the portfolios we build, the rabbit holes we jump down, and whether we read and retweet Fred Wilson’s latest articles.