Loss Ratios In Early Stage VC

When I was early in my career, I casually mentioned to an older VC that I had yet to lose money on an investment. He replied "that's not good, you aren't taking enough risk." I have gone on to lose a lot of money over the years. And made a fair bit too.

So one of the things I like to look at when I look at our funds and other VC funds that I am an investor in are loss ratios. You can calculate loss ratios by "names" meaning how many investments ended up being worth zero. Or you can calculate loss ratios by "dollars" meaning how much of the capital invested in the fund went into total losses. Ideally your names loss ratio will be a lot higher than your dollars loss ratio.

Our first fund, USV 2004, has an "names" loss ratio of about 40%. That means 40% of the investments we made are going to be end up being worthless or near worthless. That fund will be the best venture fund I have ever worked on. So loss ratios are not really indicative of performance of a fund. That comes from the winners and how big they are.

I just looked at the financial reports for a seed fund I have an investment in. It has a 42% "names" loss ratio three and a half years in. That sounds about right to me. I feel good about that fund. If it had a lower "names" loss ratio, I might not feel as good about it.

I am not suggesting that a high loss ratio is indicative of good performance. It is not. But it is indicative of risk taking, and importantly, taking your lumps and moving on. The worst thing you can do in early stage VC is stick with your bad investments for too long and for too much money. If the "dollars" loss ratio is higher than the "names" loss ratio, that can well be an indicator sticking with your losers too long and that can be an indicator of poor performance.

The point of all of this is losing money comes with the territory in early stage VC. It is not something to be ashamed of. But it is something you need to be doing as quickly as you can.